While most analysts applauded Amazon’s latest move which involved planning to reduce its dependence on UPS, USPS, and FedEx, by offering its own deliveries on most of its products, we, at Market OutPerformers, believe that this step shows how far is Amazon’s focus from being a profitable company. 

Amazon’s market cap is now standing at $645 billion. Yet, it only generated $18.4 billion in cash from its operations, a metric which does not deduct what the company spent on capital expenditures and capital leases. If we include what the company spent on Capex and capital leases, the company burned (yes, a $645 billion company is burning money) $1.4 billion in cash last year. 

Well, that’s not a problem as long as money is spent wisely on growth projects that may be profitable at some point in the future. 

However, what if this money is being spent on projects that even at their best case, the profit would be negligible?

That’s what Amazon is doing and one of these projects is “Shipping With Amazon”. 

Why would a company enter this market? Fedex and UPS each have an operating margin of 8% and 11.5% respectively, and that’s after spending $36 billion and $21 billion over the last 10 years respectively. On average, that’s nearly a third of what Amazon spent over the last 10 years on Capex. Keep in mind that FedEx and UPS have been spending on their infrastructure and logistics since before the 1980s. 

We believe that by entering into this market, Amazon is:

• Increasing its capital expenditures by nearly a third at the time when it should focus on increasing its free-cash-flow.
• Distracting management from the main objective of the company which is increasing spending per user which is much lower on Amazon than on Walmart or Costco. 
• Increasing its opportunity cost as newer technologies have higher operating margins with lower capital spending required. 
• Missing the cash flow float which Amazon is currently having with its shipping partners (Amazon pushes payments to shippers and receives cash directly from customers).

In addition, we doubt that Amazon can even reach Fedex and UPS operating margins as the company is still in its very early stage of its shipping business. This business depends hugely on economies of scale; the more customers the company has, the higher the margins. Amazon doesn’t and won’t have this privilege anytime soon (UPS and Fedex each ship on average 18 million and 4 million packages every day on average compared to Amazon’s 1.6 million figure). 

We believe that Amazon will record losses from this business for a long time before recognizing any profit, again, which even at best case, is a 10% operating margin business. 

But, if we know that, then Amazon’s management definitely knows that, so why are they entering the shipping market? 

We believe that Amazon’s management doesn’t care about profits at all. Till this point, we have not seen any intention by Amazon’s management to make the company really profitable or cash flow positive (we are not talking about the positive cash flow you see today which is inflated by some financial engineering, we will talk about this point in the second edition). 

Market OutPerformers believe that Amazon’s management needs to increase the company’s total addressable market which translates to a higher valuation on the sales front (the higher the TAM, the higher the price-to-sales ratio a company should get). For instance, when the company announced entering the on-demand music and video business, its stock went up significantly. That also happened when Amazon announced its plans to acquire Whole Foods, and when it announced its Fire and Kindle devices. This strategy is also followed by Tesla’s Elon Musk where 

By increasing its TAM, Amazon is having a high price-to-sales ratio for a retailer. For instance, Amazon PS ratio is 6x more than that of Costco’s while only having 3x the growth rate and with lower operating margins (3.2% for Costco vs 2.3% for Amazon). 

Increasing TAM is a good strategy as long as new markets are worth the time and the money. But in this case, we believe that the shipping industry does not suit a company worth $645 billion which is building its retail network technology.  

The new world of specialization and differentiation makes vertical integration a wrong choice by a company which is not bounded by one supplier or business partner. Amazon is not limited to one shipping partner, Fedex, UPS, and USPS all compete to win Amazon as a customer. Thus, we believe there is no need for Amazon to ship its own products at the expense of its shareholders.  We would like to see more profits and real cash flow from Amazon before considering buying the stock at these levels. As a result, we rate Amazon stock as a “sell”.