In some ways, Amazon's (AMZN -1.38%) stock looks like a no-brainer buy at the current price.
Shares of the tech giant are still down 46% from their peak in 2023, and Amazon retains the same competitive advantages that have made the stock such a big winner over its history. Those include its Prime loyalty program, which has more than 200 million members, a robust logistics and fulfillment network, a third-party marketplace with millions of sellers, a near-50% market share of e-commerce in the U.S., and the leading cloud infrastructure business, AWS.
However, Amazon bulls calling the stock cheap overlook a more pressing challenge facing the company.
Amazon significantly expanded its capacity during the pandemic, and it now seems clear that was a mistake. The company misread the trendline, assuming that e-commerce demand would remain robust even after the economy reopened and consumers could again safely shop in stores and go out to restaurants and other such activities.
Image source: Amazon.
That error was on display in Amazon's latest earnings report, and it explains why its 2022 financial performance was so weak. Overall revenue growth slowed to just 9% for the year, and operating income was slashed in half to $12.2 billion as the company reported a $10.5 billion operating loss in its business segments (excluding AWS). For the year, its operating income was the lowest since 2017. Even fourth-quarter operating income at AWS was down slightly from the quarter a year ago.
While the macroeconomic headwinds offer one reason for the struggles, CEO Andy Jassy gave a better explanation on the earnings call.
Amazon committed a tactical error
Asked if and when Amazon would drive profitability in its North America segment, Jassy said:
"It's important to remember that over the last few years, we've -- we took a fulfillment center footprint that we've built over 25 years and doubled it in just a couple of years.
And then we, at the same time, built out a transportation network for last mile roughly the size of UPS in a couple of years. And so when you do both of those things to meet the huge surge in demand, you're going to -- just to get those functional ... it took everything we had. And so there's a lot to figure out how to optimize and how to make more efficient and more productive."
Indeed, Amazon's expansion of fulfillment centers and last-mile capacity during the pandemic was a tremendous undertaking, and a big part of the reason why the company spent nearly $125 billion in capital expenditures over the last two years, driving significant free cash flow losses in both years.
Given those losses and the scale of its investments, Jassy seems to be tamping down expectations for 2023 when he says, "There's a lot to figure out how to optimize and how to make more efficient and more productive." Typically, businesses, especially those of the caliber of Amazon, have those things figured out when they decide to spend tens of billions of dollars on a project.
It seems that Amazon was blindsided both by the pandemic and then again by the reopening as its 9% revenue growth in 2022 represents its slowest annual growth rate ever. It's also closed and canceled plans for dozens of warehouses, a clear sign that it overexpanded.
Beyond those overinvestments, Amazon may be running into structural challenges in addition to the macro headwinds. With more than $500 billion in annual revenue, just growing the business by 20% would mean adding $100 billion in revenue in a single year, a tall task for any company.
What it means for Amazon investors
Amazon isn't a broken company by any means, but Jassy's comments should be a wake-up call to investors expecting a quick recovery in the stock. The company's recent earnings report also showed that even AWS is starting to look mortal with revenue growth slowing to 20% and a decline in operating income. The stock looks expensive based on its current growth rate and profitability.
Over the longer term, Amazon's strength should reemerge, but 2023 looks set to be another challenging year, especially given the macro headwinds. After doubling its fulfillment capacity, it will take the company time to "figure out" how best to leverage that massive investment. Investors will need to exercise similar patience.
