Outlook: Amazon Management Gets More Ambitious

Amazon Fresh

Amazon.com (NASDAQ:AMZN) will increase the monthly fee and transaction fee its charges for webstores on February 4. Fees are charged to third parties for the privilege of maintaining a store front that can be accessed via the Amazon.com website or for listing products on the Amazon.com website; many national and international brands maintain store fronts on the site, and countless private businesses sell goods listed on the site under “Selling on Amazon.”

Amazon currently charges a $39.99 monthly subscription fee for webstores, referral fees for Selling on Amazon, and transaction fees for each item sold. The monthly subscription fee will increase to $79 from $39.99 for webstore only and to $79 from $0 for webstore plus Selling on Amazon. The fees for Selling on Amazon are as follows: a referral fee for each item sold, a variable closing fee for each media item sold, and a $0.99 fee per item sold for individual selling plans (as opposed to professional selling plans). In addition to the subscription fee increase, the transaction fee for webstore plus Selling on Amazon will increase to 2 percent of sales proceeds from 1 percenr, with webstore only remaining at 2 percent.

An Amazon webstore benefits retailers by driving traffic, integrating with Checkout by Amazon, and allowing fulfillment by Amazon. Webstores facilitate easier and quicker sales to Amazon’s large customer base, including its “tens of millions” of Amazon Prime members worldwide who agreed to pay $79 per year for expedited shipping, among other perks. This expedited shipping, in addition to signing-in using Amazon credentials, becomes available to the consumer who purchases from an Amazon webstore, a key differentiator as online purchases from non-Amazon websites can take a week or more for shipping alone.

Amazon will also increase many of the fees charged for Fulfillment by Amazon on February 18. The affected fees include fulfillment fees, monthly storage fees, inventory placement service, and apparel handling service. According to the company, the fees are intended to address rising customer service, fulfillment, storage, and transportation costs.

We see these fee increases as a signal of Amazon’s confidence in leverage over third parties, and believe they serve as an indicator of profit acceleration. We believe the increases will be absorbed due to retail partner satisfaction with and dependence on Amazon’s webstore services. The increases suggest to us that Amazon is more committed to generating profits; we have modeled significant earnings growth in 2014, as we expected to see signs of operating leverage. We are maintaining our Amazon estimates as the rate increases are already factored into our long-term projections. We have long believed that Amazon will increasingly attempt to find ways to augment profitability in coming years as its influence on online and offline shopping grows.

These fee increases are evidence of a greater focus on profitability. Maintaining our NEUTRAL rating and $330 price target, our PT reflects a P/E multiple of 50x our hypothetical FY:19 EPS of $8.38, discounted back five years. Our rating is based on our assessment that Amazon is unlikely to provide investors with a strategy road map. We are not convinced that the company will share sufficient details about spending plans to allow us to accurately model profit growth, and it could be a long time before EPS grows sufficiently to justify its share price.

Investment thesis

Amazon is a dominant online retailer well on its way to becoming one of the world’s largest retailers. The company enjoys considerable advantages over its brick-and-mortar competitors, due to its low direct overhead. Amazon management is quite ambitious, expanding into expensive digital media through its Kindle hardware and Prime video streaming, depressing the company’s earnings power. Similarly, the expansion of Amazon Web Services has thus far been quite costly, although we think that AWS is at a tipping point and will generate significant leverage going forward.

In order to take a position in Amazon, we believe investors must make a leap of faith that its revenues will continue to grow and will generate high contribution margin; we have made the leap of faith on revenues, but the lack of visibility on contribution margin gives us pause, and we prefer to stay on the sidelines. Accordingly, we are maintaining a NEUTRAL rating on Amazon shares.

Risks to the attainment of our share price target include a lack of financial visibility, increasing competition, changes in consumer preferences, changes to the terms or economics of its agreements with its customers or suppliers, dependence on its shipping partners, macroeconomic factors, an evolving tax environment, and legal, regulatory, and security risks, among other factors.