Amazon (AMZN +1.00%) has been one of the hottest stocks on the market for a long time now. The stock is up 42% year to date and there seems like no end to the climb.
But this year some cracks in the facade started to emerge. Profitability is way down, growth is slowing, and some of Amazon's most promising markets don't look quite as attractive as they once did. So here are the three biggest challenges facing the company as we go into 2013.
Always the lowest price -- or else
Amazon has attracted a lot of customers with low prices, and that's the calling card of its biggest business. The company is competing with brick-and-mortar discounters like Target (TGT 0.93%) and Wal-Mart (WMT +2.88%), as well as online retailers like eBay (EBAY +3.32%). In this industry, price is your main advantage, but competing on price doesn't necessarily help profits.
Over the last seven quarters, Amazon has gone from a profitable, fast-growing online retailer to a barely profitable retailer with growth that's slowing dramatically.
AMZN Net Income TTM data by YCharts.
I can use myself as an example of this challenge for Amazon. I'm a first-time Prime member this year and I love the ease of ordering from Amazon and the "free" shipping I get. But there's little doubt in my mind that I'm an unprofitable customer for Amazon. I order items that are inexpensive, where two-day shipping is probably more expensive than the item itself, and I always know that Amazon is giving me the best price. This is the definition of a low-margin, low- or no-profit customer.
Amazon may be able to attract customers with features like Prime and low prices, but the challenge with this is there's little loyalty in online shopping. The barriers to entry are low and the business will face fierce competition from brick-and-mortar retailers trying to stay relevant in the future. So far, that's meant little to no profit for Amazon and it looks to continue into 2013.
Tablets aren't a slam-dunk
When the Kindle Fire HD came out, it was supposed to be the iPad killer. But retailers are now clamoring to add the iPad to their lines, not the Kindle. Apple (AAPL 3.40%) now has Wal-Mart, Target, and Best Buy (BBY 1.42%) selling the iPad while the Kindle can only be found at Best Buy. When you're the biggest competition for retailers, they're not likely to be friendly to your new tablet devices, especially when customers aren't clamoring for the device.
There's also the question of profitability for the Kindle tablet. Amazon's CEO, Jeff Bezos, recently confirmed that Amazon sells the Kindle Paperwhite and Kindle Fire HD at cost. It hopes to make up profit on the back end by selling books and apps to consumers. But Amazon still doesn't give much data on how many Kindles its selling or if the back-end sales strategy is working. We can only watch the bottom-line trends to look for profits from the Kindle, and so far those profits don't exist.
More low margin growth ahead
Amazon has a lot of growth avenues on its plate. Beyond online retail, which is still the company's bread and butter, there's streaming and cloud services. But there are challenges with these businesses being highly profitable long-term.
Netflix (NFLX +14.03%) showed over the past year that streaming isn't a profitable business when content providers discover you're making money. Amazon and Netflix are in an arms race for content and it'll kill the profit either one is able to generate in streaming. Just look at what happened to Netflix's profit despite growth in revenue.
NFLX Net Income TTM data by YCharts.
On the cloud side, Amazon has posted impressive growth in the cloud, with its business unit growing 64% from a year ago. But Amazon recently announced a 25% price cut for its cloud storage services to compete with price cuts from Google (GOOG +1.50%). The cloud is another business that has extremely low barriers to entry, so there's no reason to think this will be a higher-margin business than Amazon's other businesses.
Many questions ahead
With income falling and competition only getting stronger and smarter, I think these questions are reason enough to stay away from Amazon's stock. In fact, I've shorted it myself.
