Amazon’s shares have fallen hard – value investors should take note

Amazon (Nasdaq: AMZN) shares have slumped by around 36% since the beginning of the year. That compares to a 28% decline for the Nasdaq index.

Investors have dumped Amazon as part of the general shift away from pandemic-winners. But there’s more to it than that – Amazon is also facing growing challenges as consumer habits change.

Over the past two years, the e-commerce industry has reaped a windfall from higher levels of consumer spending and a lack of competition from brick and mortar retailers.

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However, as the world has reopened after the disruption of the pandemic, consumer spending trends have normalised. That leaves e-tailers in a tricky position.

Companies like Amazon invested heavily in 2020 and 2021 to boost their delivery and order capacity, but it now seems as if this new capacity may be surplus to requirements. Amazon warned that its pandemic hiring and warehouse-building binge will hit profitability this year, when it reported its results for the first quarter of 2022.

Since then, two of its close peers, Walmart and Target, have echoed the same sentiment.

According to Bloomberg, Amazon is now reportedly looking to sublet at least ten million square feet of space and could “vacate even more by ending leases with landlords,” as it tries to unwind some of the excess capacity built up during the pandemic.

Getting these costs under control is vital if the business is to get back on track. Operating expenses hit $112.7bn for the three months to the end of March. To put that figure into perspective, sales in the quarter rose by just 7.3% to $116.4bn.

With revenue growth failing to keep up with cost growth, it’s not really surprising that Amazon reported a net loss of $3.8bn for the period (although this did include a non-operating expense of $7.6bn from its investment in electric carmaker Rivian Automotive Inc).

The profits may be vanishing but Amazon’s competitive advantages remain

These negative headlines haven’t helped investor sentiment towards Amazon. Analysts have questioned the sustainability of the firm’s retail business for the past 30 years, and the current issues are only serving to rekindle these concerns.

Still, retail has become almost a side show as Amazon’s cloud business has ballooned. Amazon Web Services (AWS), the cloud services division that generates virtually all of the group’s profit, reported a 37% jump in revenue for the period and an operating margin of 35.3%.

While the retail businesses generated an operating loss of around $2.9bn on sales of $98bn, AWS earned an operating income of $12bn on net sales of $18.4bn.

With AWS throwing off cash, Amazon isn’t a traditional retail story. It can afford to weather the current storm and management has time to reposition the enterprise for today’s tougher economic environment. It still expects income for the second quarter to range from a loss of $1bn to a profit of $3bn.

I’ve never owned Amazon shares – but I might change my mind

As a business, Amazon is fascinating. It has virtually taken over the e-commerce market in the US, and is making strong inroads in many of its international markets. It has grabbed market share by investing heavily to be the best operator, and is laser-focused on making the buying process as easy as possible for customers.

And as a consumer I love the business as Amazon usually has more on offer at a lower price with faster delivery times than its competitors.

However, as an investor I’ve never owned its shares. Yes, Amazon is miles ahead of the competition – but this doesn’t come cheap. The retail arm has always struggled to earn a consistent profit, and this doesn’t look likely to change.

I’ve found it almost impossible to understand how the company could produce returns for investors while losing money at its biggest division. Unfortunately, this hesitancy has caused me to miss out on some substantial profits. Amazon shares have returned 116% over the past five years, outpacing the FTSE All-Share’s paltry return of 0% excluding dividends.

Still, while I’ve avoided the business in the past, that does not mean that I will always do so. We’re entering an uncertain period, and one thing is clear – Amazon has the size and scale to ride out this turbulence, particularly with the AWS arm providing a vital stream of profits and cash flow.

Walmart and Target (among others) don’t have this competitive advantage. Amazon has the scope to capitalise on growing economic uncertainty and its large economies of scale in future, by offering consumers more for less and grabbing market share. At the same time, based on the growing pipeline of work for AWS, this division seems likely to continue to act as a profit centre.

So while Amazon shares may not be an outright “buy”, there’s certainly value emerging. The stock is likely to remain volatile as uncertainty persists, but it could emerge stronger on the other side of the current crisis. Investors brave enough to row against the tide may benefit from taking a long-term view of the business.