- Margins in the U.S. retail segment are getting better as Amazon reaches scale.
- International markets show promise, but there’s a long way to go.
- What does Amazon need to achieve in these markets to be consistently profitable?
Amazon.com, Inc. (NASDAQ:AMZN) e-tail operations have steadily expanded over the years, growing revenues tenfold in ten years from $10.711 billion in 2006 to $107 billion in 2015. Trailing twelve months (TTM) sales stand at $120.63 billion and Amazon looks set to continue its double-digit growth into this year as well. As for Amazon’s web services, despite the strong growth in the last few years, the segment made up just $9.94 billion in TTM revenues but continues to show high margins.
Also read: Amazon Stock Will Surpass $1000 A Share
While the retail department takes care of top line growth, web services takes care of the bottom line, both complementing each other nicely.
In their attempt to go wide and deep Amazon has expanded retail operations into more than a dozen countries outside the United States, but they don’t seem to have the same problems overseas as their physical big box and wholesale counterparts.
How Amazon Trounced Big Box Co.
Almost every big-box retailer has struggled the moment it stepped outside the country. Walmart (NYSE:WMT) got out almost as quickly as it got into Germany, and despite trying so hard for so many years their Chinese dream still remains a dream. Target Corporation's (NYSE:TGT) Canadian operations have hurt the company so badly that they will think ten times before venturing out of United States again. My favorite club warehouse, Costco Wholesale Corporation (NASDAQ:COST), is still trying to win over the Australian market and with $1.3 billion in revenues from that market last year, they might still stand a chance.
The key factor to remember is that these companies have decades of experience and billions of dollars in cash flow, but to this day none of them can boast of a successful international operation where they are the number one or number two player. As a retailer, Amazon has already changed that with their success in the Indian market, and the company also has operations running successfully in Australia, Brazil, Germany, Canada, the U.K., France, Spain, Italy, Netherlands, China and Japan.
But China is a different beast. It is by far the worst market for foreign companies, and with Alibaba holding its numero uno position there with able support from the governement, Amazon is never going to get a level playing field in that country. There may be trillions of dollars to be made in the Chinese retail market, but if you are an international player then you can forget about it. Even Amazon only holds a single-digit market share in the country, and I believe only a miracle can change that.
Home Versus Outside
Retail companies invariably work on low margins, and when you add e-commerce that brings in the high shipping cost into the picture, the margins are literally wafer-thin. The best way out of this problem is to move a large volume of goods to compensate for low profitability.
After many years of moving between being profitable and making losses, Amazon’s US operating margins have steadily gone up in the last eight quarters, thanks to increasing scale and size at home. Amazon recorded $71.177 billion in sales in its home country in the last four quarters, with an average profit margin for the period touching 5.07%, a huge improvement from the company’s historicals.
In the international markets, however, Amazon’s retail division is yet to reach that same scale, so although they made $9.844 billion during Q2, they posted an operating loss of $135 million. What they need to do is to get to the top in each of these international markets and then grow beyond the scale any local player can reach. They’re already No. 1 in the Indian market, but in terms of significant top line and bottom line gains, they still have a long way to go.
India is set to quadruple its e-commerce volume over the next 4-5 years to hit $106 billion, and that entire market potential in 2020 is what Amazon made last year from retail and tech services. But if they can grab a significant portion of market share from local players like Flipkart and others, they have a chance to make India their second largest market after the United States.
After that, it’s merely a question of scaling up further and creating efficiencies in their shipping before they start showing mid single-digit operating margins. As such, the Indian subcontinent will eventually play a major role in Amazon’s overall revenue and profitability overseas.
The Formula Repeated
But the real key for Amazon is to hit that critical volume in the majority of countries that they currently have a presence in. Only when that happens can they become consistently profitable in their overseas retail operations.
$10 billion from outside the U.S. looks like a small number, but flip that idea around and you’ll see the massive potential waiting for them to grab onto. The growth runway is there for several years more, but markets like India, Europe and South America are critical to their success - more so because they have a good chance of being the dominant player in each of these geographies. It’s a rare feat for a U.S. retailer to be truly successful outside the country, but Amazon is definitely within reach of that goal.
Considering the growth runway, a 3.1 times sales multiple makes the stock look reasonably priced.