Profit Story Part 3 – The Amazon Syndrome Threatens US Business Profit Margins
The focus of this and my previous two posts is business earnings. The obvious reason is that stocks are our primary investment vehicle, and the primary driver of stock prices is earnings. Earnings in turn can be broken into sales times the profit margin on those sales. This chart, which I’ve shown before, shows that US profit margins are currently hovering near record levels.
Source: Bureau of Economic Analysis (BEA)
My last two posts discussed two drivers of the improved profit margins over the past few decades:
- Growing trade, which helped US businesses gain the upper hand over US labor.
- Growing oligopolies, which reduce competition and help businesses gain power versus their customers (think crowded airplanes) as well as those employees again.
This post delves into a counter-trend for profit margins, namely what I call the “Amazon Syndrome”.
Amazon is obviously a remarkable company. It has become the dominant force in retailing by mastering online selling, and in particular the movement of goods (logistics gone sexy) and sales data storage and usage (the mysterious and all-knowing Cloud). One other remarkable feature of Amazon has been its patience in delaying earnings in order to invest in logistics and the Cloud, and to build market share by underpricing competitors. Check out this chart of Amazon’s earnings per share history:
Source: Company reports
This hugely delayed gratification of investors’ love of profits really is pretty unique in American business history. We investors like our profits, and we like them now. But here was Amazon holding off for two decades.
And it turns out that investors loved it! Amazon is now valued at $880 billion, just a chip shot away from passing Apple as the world’s most valuable company. And it just hit 100 times its IPO price of 21 years ago. You held onto your Amazon shares since then just like I did, right?
Success attracts its imitators; hence the Amazon Syndrome. The lesson that many entrepreneurs and their investors took from the Amazon story was “sales growth at all costs”. This chart compares the earnings per share (EPS) history to date of publicly traded three imitators – Wayfair, Blue Apron and Tesla:
Sources: Company reports
Even bigger losses than Amazon. And Wayfair, Blue Apron and Tesla are far from alone. A few other stories from around the business world:
Real estate. WeWork is a real estate owner trying to catch the Amazon Syndrome vibe:
“WeWork Doubled Revenue Last Quarter. Sales rose 110% to $342 million…In the latest financial disclosure, WeWork again included a nonstandard earnings metric it calls community-adjusted EBIDTA, despite drawing derision from analysts in the past. It was $95 million in the first quarter. The figure…leaves out central operations, such as HR and legal, as well as ‘growth expenses’ associated with expanding to new markets and building products…WeWork lost $933 million on sales of $886 million in 2017, according to documents associated with a bond sale in April.” (Bloomberg, June 14, 2018)
Investors clearly have ignored that analyst derision – WeWork is now valued at over $20 billion.
Ride sharing. Taxi dispatching used to be a grimy low-profit business. Uber turned it into a sexy big-loss business. Its $4½ billion loss last year was exciting enough to bring its current valuation to about $50 billion. And rival Lyft just raised money at a new high $15 billion valuation. While Lyft doesn’t publicly brag about its losses, The Los Angeles Times noted last November 9 that “Fierce competition from Lyft is holding Uber back from achieving profitability in the United States, Uber Chief Executive Dara Khosrowshahi said”.
Apparently the ride sharing companies can’t lose money fast enough in their traditional auto business. So they are now fiercely competing with multiple start-ups in bike-sharing and scooter sharing businesses. Believe it or not, according to Pitchbook News, ““In venture capital land, it seems like every day brings scooter news.” Scooters? Seriously?
Soon everybody else? Putting sales growth before today’s profits is OK for these New Age companies, but not traditional companies, right? Maybe less so now. A wakeup call for me was this short article is quoted in full from The Wall Street Journal (June 30, 2018). It reports on the fiscal first quarter results of liquor company Constellation Brands:
“Strong beer sales offsets drop in wines and spirit sales at Constellation Brands but grape and transportation costs squeezed the company’s margin. Beer sales at the company rose 11% from the comparable quarter a year ago to $1.38 billion in Constellation’s latest quarter, helped by brands such as Corona and Modelo. Wine sales, however, fell 1.7% to $592 million, while sales of spirits – a much smaller segment compared with beer – declined 8% to $80 million. Constellation attributed the lower wine sales to timing. The comparable quarter a year earlier was lifted by a replenishment in its supply of Meiomi wines, making up for a shortage.”
Seems pretty innocuous. But I noticed that this earnings report ignored one fact – EARNINGS! Not a single mention. The article was all about sales.
Will the Amazon Syndrome spread enough to materially squeeze Corporate America’s profits? I’m starting to worry. I believe an interesting barometer will be mattress maker Tempur Sealy International. What could be more boring than the mattress business? It must have unit sales growth in the 1-2% range. But in recent years many – I have heard up to 50 – startups have entered the business. You’ve probably seen ads for one of them, Casper. Hit up Casper on Google, and you can learn about Tuft and Needle. Or Loom & Leaf. Or Leesa.
All of that new competition will certainly weaken industry profit margins. Sure enough, Tempur Sealy’s last two earnings reports were disappointing, and earnings estimates declined. If I am right, Tempur Sealy faces more bad earnings reports over the next few years. How well will its stock fare through the coming turmoil? And how many other industries and companies will have to face the same pressures?