Labor Shortage? Amazon Will Automate That (NASDAQ:AMZN)

Amazon.com, Inc. (NASDAQ:AMZN), once a shining star during the pandemic era, has seen a 38% drop in its stock value over the past year. Investors are worried about the pressure on margins caused by over-investment in 2020 to meet the surging demand for e-commerce and signs of a slowdown in the growth of Amazon Web Services (“AWS”) as the economy weakens. As a result, the company is currently trading at low valuations, with a P/E ratio of 54x and a P/EBITDA ratio of 13x based on consensus estimates for 2023 earnings.

However, this may present an opportunity for investors to invest in a company with many sustainable competitive advantages. This article will delve into one of Amazon’s key strengths: automation. As the demand for automation continues to grow in light of a secular labor shortage, we will examine how Amazon utilizes automation to maintain its competitive edge and help it grow.

Additionally, we will also analyze the company’s financials, valuation, and risks to provide readers with a more comprehensive understanding of the potential risks and rewards of owning Amazon stock.

Note: This article is for educational purposes only and does not constitute financial or investment advice. Please do your own due diligence and consider your unique financial needs and constraints before buying any stock.

Labor Shortage

The labor shortage problem today is a growing concern for many businesses and industries. It is characterized by a lack of available workers to meet the demand for labor in the economy, which can lead to increased competition for workers, higher wages, and increased automation. This problem is caused by a combination of factors, including a low unemployment rate, demographic shifts, changes in immigration patterns, and high demand for certain skills.

The unemployment rate in the United States is currently at a historically low level, which means that there are fewer available workers looking for jobs. Right now, the latest data shows that we have over 10 million job openings in the U.S.—but only around 6 million unemployed workers, according to the U.S. Chamber of Commerce. This is the result of strong demand for labor and low labor participation. Right now, the labor force participation rate in the U.S. is 62.3%, down from 63.3% in February 2020:

Demographic shifts, such as an aging population and declining birth rates, have also contributed to the labor shortage problem globally. As the number of young workers entering the workforce decreases, businesses are struggling to find the workers they need to keep up with demand.

Changes in immigration patterns have also played a role in the labor shortage problem. The recent changes in immigration policies and the ongoing political situation have led to a decrease in the number of immigrants entering the U.S., which has affected the labor force. This has made it more difficult for businesses to find the workers they need, particularly in industries that have traditionally relied on immigrant labor.

Finally, the high demand for certain skills, such as technology, healthcare, and construction, has led to a shortage of workers with those skills. The shift to remote working has made it easier for workers to move away from certain areas, and with this, some businesses are struggling to fill positions, particularly in rural areas, where workers are scarce.

Automation Advantage

Amazon has several competitive advantages in automation that have allowed it to stand out from other retailers in the industry. One of the most significant advantages is the company’s scale. As of June 2022, Amazon accounted for 37.8% of the U.S. e-commerce market, making it by far the leading online retailer the country, according to Statista. As one of the largest retailers in the world, Amazon has a vast amount of resources at its disposal to invest in automation technology. This has allowed the company to develop and deploy sophisticated automation systems in its retail stores.

Another competitive advantage is Amazon’s expertise in data analytics and artificial intelligence. The company has been using data analytics and AI for many years to improve its e-commerce operations, and it has been able to leverage this expertise to develop automation systems that are more accurate and efficient than those of its competitors. Amazon, for example, has advertised for 18,116 new artificial intelligence jobs from October 2020 to September 2021; and mentioned artificial intelligence in company filings 86 times, according to GlobalData.

In addition, Amazon’s online and offline retail operations are closely integrated, which allows the company to collect a vast amount of data on customer behavior and preferences. This data can be used to make the in-store experience more personalized, efficient and effective. Of the 4,000 products Amazon sells every minute, approximately 50% are presented to customers by its personalized recommendation engine. When you visit the site, its algorithms select an assortment of products from about 353 million items and arrange them for you according to what they predict you will want at that precise moment, according to HBR.

Another competitive advantage is Amazon’s focus on innovation. The company has a long history of experimenting with new technologies and business models, which has helped it to stay ahead of the curve in the retail industry. Amazon’s willingness to take risks has allowed it to test new forms of automation and other technologies in its stores, which has helped the company to gain valuable insights and improve its systems over time.

Amazon’s competitive advantage in automation is driven by its large scale, expertise in data analytics and artificial intelligence, access to a vast amount of customer data, and a culture of innovation. These factors work together to create a powerful virtuous cycle, which enables the company to continuously improve its automation systems and gain a significant edge over competitors. This virtuous cycle is likely to drive the company’s growth and competitiveness, regardless of the broader economic and market conditions.

Automation Investments

Amazon has invested in automation in three key domains: warehouse, delivery, and retail stores.

Warehouse Automation: Amazon has made significant investments in warehouse automation in order to improve efficiency and reduce labor costs. One of the key technologies they have implemented is the use of robots, specifically the Kiva robots. These robots are mobile and can navigate around the warehouse, transporting shelves of products to human pickers. This allows for faster and more efficient picking of orders, as the pickers no longer have to walk around the warehouse to gather items.

In addition to the Kiva robots, Amazon has also implemented other automated systems in its warehouses such as conveyor belts and sorting machines. These systems help to streamline the process of getting products from the warehouse to customers.

Amazon has been working on several other projects to enhance warehouse automation. One of these projects is the introduction of autonomous mobile robots called “Rovers.” These robots are designed to move merchandise around the warehouse and work alongside human workers to make the process more efficient.

Another project the company is working on is the implementation of voice-controlled technology for pickers. This technology allows pickers to use their voice to receive instructions and fulfill orders, which can increase the efficiency of order fulfillment.

In addition, Amazon is working on a new concept for its warehouses called “Amazon One.” This uses a combination of automation and human workers to sort and package items. This concept is aimed at improving the efficiency and accuracy of the sorting and packaging process. The goal is to create a more seamless workflow between the machines and human workers, making the operation faster and more efficient.

Delivery Automation: Amazon has invested heavily in delivery automation in order to make the delivery process faster and more efficient. One of the key areas of investment has been in drone technology. The company has been testing delivery drones, which are designed to fly to a customer’s location and deliver packages directly to their doorstep. According to this 12/2022 article, Amazon has begun drone delivery in two cities in the U.S.

Another area of investment has been in autonomous delivery vehicles. Amazon has been testing self-driving delivery vans and trucks, which are designed to drive to a customer’s location and deliver packages. These vehicles are equipped with sensors, cameras, and other technologies to navigate the roads and avoid obstacles. In January 2021, Amazon announced that it has over 100 autonomous delivery vehicles in operation. However, results have been mixed. For example, the company recently announced that it will shut down the test pilot of its home delivery robot, Scout, due to uneven results.

In addition to the drones and autonomous vehicles, Amazon has also invested in other delivery automation technologies such as package sorting and handling systems, machine learning algorithms, and tracking and monitoring systems, to name a few.

Retail Stores: Amazon has been testing and deploying various forms of automation technology in its physical retail stores in recent years. One of the most notable examples is the use of cashier-less technology, also known as “Just Walk Out” technology, in its Amazon Go stores. This system uses a combination of cameras and sensors to track customers as they move through the store, and automatically charges their Amazon account for the items they take off the shelves. This eliminates the need for customers to wait in line to check out, and reduces the need for cashiers. Amazon now operates 30 Amazon Go stores, including 24 in Chicago, New York, San Francisco and Seattle.

Financials & Valuation

In 2020, Amazon’s revenue experienced significant growth due to the COVID-19 pandemic and the implementation of multiple rounds of government stimulus totaling ~$5 trillion. The pandemic led to widespread shutdowns and an increase in online shopping, resulting in year-over-year revenue growth of 37.6%, compared to 20.5% in 2019. Despite the challenging economic conditions, the company’s revenue continued to grow robustly in 2021, at 21.7%, fueled partly by the continuation of the low-interest rate environment and an additional ~$2 trillion in government stimulus.

At the time, sentiment for technology stocks was highly bullish, with many executives believing that the pandemic had permanently accelerated the demand for their businesses. Amazon’s management team was among those who held this view. As a result, the company increased its operating expenses in 2021 in excess of its revenue growth, resulting in a compression of operating margin by ~60 basis points. Additionally, capital expenditures increased by 58.1% in 2021, following a 176.2% increase in 2020, leading to higher depreciation expenses for many years.

In 2022, as inflation and Fed Fund rates took a sharp turn higher, Amazon’s e-commerce business ground to a halt and is expected to contract by ~1% for the year, decelerating the total revenue growth to just 8.6%. Given the significant shortfall on the top line, operating margin is expected to compress by ~290 bps. AWS also flashed warnings as Q3 revenue went up 27.5%, a significant deceleration from 33% revenue growth in Q2.

Consensus estimates for 2023 forecast a modest 10% revenue growth, and a more robust operating margin expansion of ~150 bps to 3.9%, driven by management’s focus on right sizing its cost structure for the new economic reality. On these reset expectations, the company is trading at a forward one-year P/E of 54x and EV/EBITDA of 13.2x, both near its all-time lows.

Risks

Numbers may still be too high: As we look towards 2023, it is important to consider the potential downsides to current forecasts, as they may be overly optimistic. Risks to the company’s performance include a possible continuation of the deceleration in growth for AWS and a lack of recovery in the e-commerce sector. During a recession, enterprise customers may prioritize cost-cutting measures and re-evaluate their spending on cloud infrastructure, something they did not worry about during boom times. Additionally, it is possible that the e-commerce market may not return to the levels seen in 2021 over the next year, as that growth may have been driven by an unlikely combination of government stimulus, low interest rates, and widespread lockdowns. Investors should approach these forecasts with a healthy dose of caution and be prepared for the possibility of a prolonged recovery period.

Investments in automation may not generate an attractive ROI: Amazon recently halted its home delivery robot field test, Scout, and reduced the team working on it due to inconsistent results. This is part of a larger cost-cutting initiative by CEO Andy Jassy, prompted by lower-than-anticipated revenues and a weakening global economy. The return on investment for automation investments may have been inflated by a decade of low interest rates and a strong economy post-2008 financial crisis. With the prospect of higher interest rates and a slowing global economy, Amazon may decrease or eliminate other automation investments.

Government regulation may increasing constrain the company: Regulatory action by government bodies is likely to pose the greatest risk to Amazon, rather than competition from other companies. Amazon, along with other technology giants like Google, Facebook, and Apple, is facing regulatory scrutiny on various fronts. Currently, much of the focus on Amazon centers around claims that the company duplicates popular products of merchants on its websites and sells them under its own brands. As governments worldwide are faced with economic downturns or geopolitical uncertainties, they may increase regulations and penalties on technology companies like Amazon that they perceive as a threat.

Conclusion

The shortage of labor is a long-term issue that businesses worldwide, particularly those in the United States, must confront. In this scenario, Amazon.com, Inc. is well-positioned to utilize automation to establish a lasting competitive advantage against its rivals. Nevertheless, despite a more attractive valuation following a year of underperformance, there are several risks associated with owning Amazon shares, including possibly high consensus estimates, inadequate return on automation investments, and escalating regulatory challenges.