Authoring Kindle ebook from MS Word document - how to prevent pictures from stretching?

Using MS Word to author Ebooks is probably the worst route you can use. I author in markdown and convert that to EPUB formats using Pandoc, it's much more reliable and has worked on 2 ereader apps and 2 different KOBO ereaders. Using MS Word is full of pitfalls and bugs.

You can also write directly in Calibre or Sigil then convert to the format you need. After every conversion make sure to check every page of the ebook on several ereaders. Different ereaders will not render the pages in the same way. Especially watch for bulleted material, quoted material, and header formatting, along with images.

I would like to answer my own question.

What did not work

If you convert the DOCX to MOBI using the Export option of Amazon's Kindle Previewer tool then you are going to face the problem with images stretching horizontally

What worked

1. Convert the DOCX to filtered HTML (Save As dialog)
2. Use Calibre to generate a MOBI file by pointing it to the HTML file that was exported out of MS Word
3. I had to fine tune some settings in Calibre (e.g. show ToC at the beginning). But, the result is very close to what I had expected.