13
Faster delivery is prompting more and more people to turn to Amazon to buy paper towels and other everyday items. It’s a great situation for busy shoppers. It’s a double-edged sword for investors – at least for now. As drugstore chains struggle and close stores left and right, Amazon has positioned itself to fill that void and capture more of the spending on items people might stop to pick up on their way home from work – things like dish soap, nonperishable food and other personal health care products. Like it’s done so many times before since its inception selling books online, Amazon is taking a short-term financial hit to grow its business for these products, with a plan to improve profitability down the road. It’s the Amazon playbook. Investors should trust that it will pay off again this time around. The growing prevalence of one- and same-day delivery has made Amazon a much more convenient to place to shop for everyday essentials. Realize in the morning that you’re running low on dish soap? Amazon can have a fresh bottle of Dawn at your place tomorrow. No need to stop at the drugstore. The problem with that scenario: fulfilling more orders for these items – particularly those with lower price points – has impacted topline growth and squeezed profits, as Amazon’s messy second-quarter earnings last month showed. The report sent the stock tumbling, though it’s now clawed back all those losses. We expect this to be a classic case of short-term pain for long-term gains. “If people buy everyday essentials on Amazon, they’re more likely to buy other products too,” said Jeff Marks, the Club’s director of portfolio analysis. “It may hurt margins now, but Amazon will probably find a way to fix that in the future.” At the end of the day, he added, “It’s about wallet share.” Amazon has positioned itself to capture more of that wallet share through a yearslong effort to speed up delivery for Prime members. On its Aug. 1 earnings call, CEO Andy Jassy said that so far this year, more than 5 billion units arrived the same or next-day. On Amazon’s corresponding earnings call in 2023, Jassy put the figure at 1.8 billion. This added convenience in ordering everyday essentials from Amazon comes at a challenging time for physical retailers known for selling those same products. Walgreens and CVS are shuttering locations and reporting declining comparable store sales for their non-pharmacy operations. Elsewhere, Rite Aid is now operating as a private company after it filed for bankruptcy last year and closed hundreds of stores in 2024. “The overall experience of shopping at a drugstore has deteriorated very badly for many people over the past few years as items get locked,” said Gil Luria, an analyst at D.A. Davidson who covers Amazon. Items from razor blades to deodorant are being locked up because of theft and other forms of what the retail industry calls shrinkage . It’s not only a drugstore problem. We’ve heard it from Target and others, too. It’s another way Amazon can remove friction at the point of purchase, not to mention the convenience of quick delivery right to your door. “One look at Walgreens, one of Amazon’s main competitors, tells you that if you are in a town that Walgreens dominates, be prepared to be dominated by Amazon,” Jim Cramer wrote in his Sunday column . In other words, the opportunity for Amazon to keep serving this market is only growing. So is the need to make it more financially lucrative than it currently is. AMZN YTD mountain Amazon’s year-to-date stock performance. Amazon’s second-quarter e-commerce revenue came in below consensus, as did profitability in North America. Online store sales grew just 4.6% on an annual basis in the April-to-June period, down from 7% in the first quarter — despite unit volume growth accelerating. The divergence can be explained by people ordering cheaper stuff, translating to lower average selling prices, or ASPs, executives said. Part of the dynamic is inflation-wary shoppers trading down to cheaper alternatives for products. This weaker consumer also factored into Amazon’s disappointing guidance last month. It’s not ideal, but in theory, it should abate as economic conditions improve. Another factor behind lower ASPs is the “growth of our everyday essentials business and categories,” CFO Brian Olsavsky said on the earnings call. That appears to be a more durable trend. Amazon wants it to be. The company likes “to be in the consideration set for consumers” in the everyday essentials since it helps drive market share gains, Olsavsky said. For now, the market share drive is dinging the top and bottom lines. “As average selling price comes down, there is pressure on the unit economics and the contribution margins on the business,” Wells Fargo analyst Ken Gawrelski said in an interview. Some expenses associated with delivery are generally held constant no matter what’s being delivered. So, the more pricey the packages being dropped off, the higher profit-per-unit, Gawrelski said, adding that delivering low-priced items may in some cases even result in losses for Amazon. The changing nature of what’s being ordered on Amazon was enough for Morgan Stanley to lower its sales and earnings estimates for this year and the following year. Last month, analysts reduced their 2024 and 2025 sales outlooks by 1% and 2%, respectively. They also lowered their earnings before interest and taxes (EBIT) and earnings per share (EPS) estimates for 2025 by 12% and 11%, respectively. The growth of orders for products with lower ASPs and margins — combined with the slower-than-expected development of other profit drivers such as reduced logistics costs — “is weighing on profits more than we thought,” analysts wrote in an August note to clients. It remains “critical” for Amazon to keep pursing a larger everyday essentials business, “given they make up 45% of the remaining offline consumer spend,” the analysts wrote. However, Amazon “needs to demonstrate an ability to deliver growth and profitability … even as its product mix continues to shift toward lower margin items,” they added. Morgan Stanley kept its buy rating on the stock, but removed its top-pick designation. Executives understand the task ahead. “[At] the same time we’re growing and inventing, we’re also continuing to make progress on our cost structure and operating margins, which isn’t easy to do,” chief executive Jassy wrote Monday in a memo to employees announcing a return to a five-day in-office policy . Bundling is a key lever Amazon can pull to improve margins on shipping essentials, according to D.A. Davidson’s Luria. “The more categories they’re in, the more they condition the consumer to order spontaneously,” Luria said in an interview. Amazon can then “bundle those throughout the day … and ship those products together, thus further reducing shipping costs per item.” In fact, Jim said Amazon is using artificial intelligence to help make that process easier. That’s important for investors, he said, because sending only one package a day to a household would “dramatically lower costs .” He predicted positive news on this front soon. Amazon’s fulfillment network overhaul that began after the pandemic boom in e-commerce — known as its so-called regionalization strategy — is a common link between the faster shipping speeds that makes ordering everyday essentials more attractive and the opportunity to batch items together in one shipment. A foundational goal of the regionalization effort is making it less expensive to deliver packages. Significant progress has already been made, which has enabled Amazon to carry a broader product assortment. There’s room for the selection to get even broader as shipping costs fall further, Jassy said on the August earnings call. Like all retailers, Amazon will need to continue weathering the storm of softer consumer spending. But when it clears up, the strategic and financial benefit of Amazon’s growing essentials business should be easier to see. (Jim Cramer’s Charitable Trust is long AMZN. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
An Amazon contract worker stacks packages onto a luggage cart outside an apartment building in New York on April 16, 2024.
Angus Mordant | Bloomberg | Getty Images
Faster delivery is prompting more and more people to turn to Amazon to buy paper towels and other everyday items. It’s a great situation for busy shoppers. It’s a double-edged sword for investors – at least for now.