(This is a reprint of my SeekingAlpha article, which is now behind a pay walled.)
- Trump pressures USPS to raise rates on Amazon, but his case is weak.
- Amazon is well positioned to win this battle.
- Q1 earning is coming: buy the dip on a potential acceleration in investments.
As you probably know, the President of the United States, Donald Trump, has been going on a rampage against Amazon (NASDAQ:AMZN) lately. I won’t summarize his rants here since they are well covered by the media (example), and because going through Trump’s Twitter (NYSE:TWTR) feed is a nauseam-inducing exercise I’d rather avoid. After speaking with sell side and buy side analysts, I believe the consensus market view is that most of Trump’s statements are nonsense. For example, his intention to go after Amazon on antitrust grounds is unlikely to go anywhere (a big topic for another article).
However, many investors are taking Trump’s executive order, issued Thursday night seriously to audit the USPS after accusing Amazon of costing tax players “many billions of dollars” by using USPS as its “delivery boy“. The situation is murky and investors are unsure how to react to this development. For example, nobody really knows how much USPS is making or losing on its Amazon business, and there are only estimates of how dependent Amazon is on the USPS as no numbers are disclosed. However, as a long-time observer of both Trump and Amazon, I believe Amazon will come out the winner in this battle for the following reasons.
USPS Says Trump is Wrong
After Trump’s attack on Amazon, former Postmaster General Patrick Donahoe, a 39-year USPS veteran who served through 2015, “unequivocally stated” to UBS analysts that Amazon is profitable for the service. His unequivocal statement is also in-line with statements made by David Partenheimer, the public relations manager for the USPS, in an op-ed written in January of this year. The op-ed is worth a read since it made multiple points that directly contradict Trump’s assertions and innuendos, although the rebuttals were directed at another person. I’d like to highlight three key points made in the op-ed.
The first key point is that e-commerce has been a growth driver for USPS, which generated revenues that “provide essential support to pay for the network and infrastructure that enables us to fulfill our universal service obligation”, benefiting “all users of the mail”.
The second key point is that the USPS operates in a highly competitive environment so it negotiates delivery rates “with full recognition of the market forces at play”. Furthermore, the USPS is legally required to charge appropriate rates.
The third key point in the op-ed is that if the USPS were to raise delivery rates substantially, its competitors would benefit by raising rates “more themselves or siphon away postal customers”, and the results would be a detriment to the consumer.
The Conclusions We May Draw & Its Implications
There are a few important conclusions we could draw from the above observations. None of them suggests that Trump will emerge the victor in this battle.
First, since Amazon accounted for nearly half of all US e-commerce sales in 2017 and taking share, the USPS really needs Amazon for its overall health. This is in stark contrast with Trump’s assertion that Amazon is causing USPS’ woes.
Second, if the USPS were to raise prices more than a fair analysis suggests, Amazon could simply move to USPS’ competitors (or build its own delivery infrastructure).
If political pressures drive Amazon away as a customer, a customer which the USPS depends on for its overall health, this could pressure the USPS financially and cause embarrassment to the White House. For example, the USPS has already made embarrassing headlines for failing to pay mandatory payments into accounts for its retirees’ pensions and health care. In other words, the USPS is in a weak negotiating position.
I believe Stifel’s recent note captures my views well: “Amazon also uses all major logistics companies in the U.S. Amazon does use USPS but, if an arrangement were to become uneconomic to Amazon, Amazon has plenty of options. What are the options for the USPS?”
Third, Trump is putting the USPS in a difficult position by suggesting that it is breaking the law by giving Amazon an “unfair deal”. Finding out if the USPS is breaking the law with its Amazon deal is likely the intention of the audit, but we have no evidence to believe that the USPS is not compliant with regulatory requirements. We do know that Trump has a personal grudge against Bezos. My hunch is that Trump is using the audit to apply pressure on USPS officials as they prepare to renegotiate rates with Amazon since the existing contract is set to expire in October of this year.
If USPS officials bow to the pressure and charges Amazon an inappropriate, above-market rate, then the USPS would be breaking the law and thus be vulnerable to embarrassing legal challenges and headlines that would erode both the USPS’s and Trump’s credibility. If the USPS does not bow to the pressure and charges Amazon a market rate, whatever that might be, it would not disadvantage Amazon relative to e-commerce competitors and thus would not achieve Trump’s objective of “going after Amazon”. This outcome would erode Trump’s reputation for effectiveness. I would call this a lose-lose situation for Trump.
Implications For Investors
Given the above discussions, it is clear to me that Amazon is in a much stronger negotiating position than Trump realizes. I believe this drama with Trump will unlikely erode Amazon’s long-term value. However, what should investors expect in the short term?
USPS asking for substantially higher rates, or even the threat of this possibility, will likely drive Amazon to accelerate its last mile investments. We’ve been through this before. In 2017, Yamato Transport was reported to have increased Amazon’s shipping rates by 40% in Japan. Like USPS, Amazon is Yamato’s largest client. Guess what Amazon did? They are now going to build “a team of 10,000 independent couriers in the Tokyo region by 2020”, according to Nikkei Asian Review.
Accelerating its last mile investments would reduce Amazon’s near-term profitability and free cash flow. Amazon recently announced that it will report Q1 2018 earnings and host a call on April 26th, after the market close. In the upcoming earnings event, if Amazon sells off on lower profitability forecasts due to higher investments, I believe investors should consider loading up on shares rather than panicking. In my July 2017 article, Amazon Bears Will Get Crushed, I explained why this is the case (Amazon shares appreciated by ~50% since my recommendation). I will not repeat myself here, but the big idea is that investors who truly understand Amazon, understands that higher investments drives competitive advantage and thus its long-term value.
In conclusion, I don’t think investors should lose sleep over Trump’s fire and fury over Amazon’s deal with the USPS. First, statements from USPS insiders contradict Trump’s assertions. Second, Amazon’s negotiating position is much stronger than Trump realizes if a battle with the USPS commences. Third, Amazon’s future lies in its own infrastructure build out, which a rate increase by the USPS will only accelerate. When all of this blows over, Amazon will still be a great company, while Trump’s future is fairly uncertain, even in the near term. Who do you think will win in the end?