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Why Amazon’s Holiday Hiring Frenzy Could Squeeze Retail Margins

Amazon is prepping more than 125,000 new employees for the 2021 holiday season in anticipation of record-breaking e-commerce demand, but a leading investment banks sees significant pressure on profits.

Morgan Stanley downgraded its stock price target for the e-commerce giant from an initial $4,300 to $4,100 as Amazon raised its average U.S. starting wage to more than $18 per hour with a signing bonus of $3,000 in some locations.

In total, Morgan Stanley says the latest hiring round, when including signing bonuses, will add north of $2 billion in costs for the fourth quarter alone. This is on top of the already estimated $1.1 billion in expected expenses for the 75,000 employees hired in March. And when tallying up head count, wage growth, expected hiring costs and benefits for 2022, the bank says the costs create a massive $8.9 billion more in incremental spending.

Amazon’s stock was valued at $3,425.52 on closing on Friday, but dipped as much as 2.2 percent on Monday in the wake of the report. The $4,100 price target still remains approximately 20 percent ahead of current levels.

“We acknowledge profit misses and slowing revenue may hold back Amazon’s ability to outperform through this investment cycle,” Brian Nowak, an equity analyst at Morgan Stanley, wrote in the report.

Amazon has increased its base wages multiple times this year, once in April and again for new hires in May, with total hourly wages including benefits during the year climbing approximately 15 percent.

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The wage bump is driving what Morgan Stanley calculates to be a 50 percent year-over-year logistics headcount cost per fulfilled unit by the fourth quarter, up from $1.99 to an estimated $2.97 in a year’s span. The hiring spike is also tying in with what the firm says is higher labor costs, which have ultimately lowered North American retail earnings before interest and taxes (EBIT) margins from 5.1 percent in 2018 all the way to 3.7 percent in 2020 and 2021 (expected).

In total, the bank lowered EBIT projections across both 2021 and 2022 by 16 percent and 19 percent, respectively, to $5.6 billion and $9.5 billion. Morgan Stanley says its 2022 EBIT estimates for Amazon are 4 percent below the current Wall Street average.

While Amazon’s high-margin revenue streams, which include Amazon Web Services (AWS), Prime subscriptions, FBA (Fulfillment by Amazon) and advertising, have thus far offset growing losses in the core first- and third-party areas of the tech titan’s retail business, Morgan Stanley’s newest model indicates the core margins will continue to decline.

EBIT margins for the marketplaces on the Seattle-based “everything store” are anticipated to dip from -8 percent in 2019 down to -11 percent for the full 2022 year. Nowak believed Amazon may be bound within the expected margin ranges until retail revenue can re-accelerate and beat expectations in the first half of 2022.

In the report, Nowak said Amazon’s scale can’t “absorb” the costs in the near-term, but he also noted that the rising wages will impact fulfillment and shipping costs as a whole.

“It is also important to remember that rising wages are impacting all businesses (most recently FedEx last week) and Amazon competitors,” Nowak wrote. “We would expect smaller (in some cases sub-scale) retailers/players to feel the pressure even more. As such, it will be increasingly important to monitor the growing retail partnerships with third-party logistics players (like Uber and Doordash) as they look for economically viable ways to continue to drive/benefit from growing e-commerce.”

While Amazon’s revenue surpassed $100 billion for the third straight period in the second quarter, profits were already starting to take a hit as the business ramped up investments into hiring, fulfillment operations and infrastructure. Net income was $7.8 billion, falling short of its $8.1 billion profit in the first quarter.

Giving some color into the business’s need to invest more capital, Amazon’s CEO of worldwide consumer, Dave Clark, said in the July earnings call that the company’s one-day delivery percentage had dropped in the quarter, and has yet to return to pre-pandemic levels.

The investment bank estimates combined shipping and fulfillment cost per unit (excluding Covid-related costs) will grow 17 percent in 2021 and 9 percent in 2022, well above the prior long-term average of 6 percent. In total, shipping and fulfillment costs minus Covid will be $129 billion in 2021, and that number is expected to grow again to $162 billion in 2022.

At $4,100 per share, Amazon would be worth a projected $2.05 trillion, with the first- and third-party businesses still only accounting for $654 million of that total. Morgan Stanley predicts total revenue to jump 23.4 percent this year to $476.2 billion, and another 18.4 percent in 2022 to $563.8 billion. Additionally, projections now indicate that Amazon will generate $46.8 billion in net income in 2022, a significant jump from the $26.6 billion anticipated in 2021. Despite the EBIT margin dip within the marketplaces, gross margins across the board are still expected to increase, from 39.6 percent in 2020 all the way up to 44.8 percent at the end of 2023.

Morgan Stanley did highlight both a bull case of $5,200 per share, where core retail is worth $960 billion and AWS is worth $815 billion, as well as a bear case of $2,300 per share.