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Amazon on Offense, Defense With 1-Day Shipping

We're planning to increase our $2,200 fair value estimate for the wide-moat firm.

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Amazon.com Inc
(AMZN)

Amazon's AMZN first-quarter update reinforced its continued shift in to a more dynamic free cash story, with subscription platforms, AWS, advertising, and Whole Foods each contributing to strong revenue growth ($59.7 billion--near the high end of guidance calling for $56 billion-$60 billion) and a new high-water mark for first-quarter operating margins (7.4% versus 3.8% a year ago). Nevertheless, it was Amazon's announcement that it plans to evolve its Prime two-day free shipping program into a one-day free shipping program that warrants the closest examination.

We see both a defensive and offensive rationale behind the one-day shipping decision. From a defensive perspective, we believe competitors such as Walmart, Target, and Best Buy have steadily been narrowing the delivery speed gap with Amazon the past 12-18 months, but we believe this move will help to reinforce the network effect component behind out wide-moat rating (with one-day delivery appealing to not only buyers, but also sellers). On the offensive front, we believe expanded one-day delivery capabilities (which will necessitate $800 million of incremental investment in the second quarter and additional investment as the year progresses) will create new third-party seller monetization opportunities and unlock new subscription service offerings, both of which are central to our longer-term assumptions.

Although Amazon plans to ramp up fulfillment and head count investments as the year progresses, we believe AWS, advertising, and subscription offerings can drive full-year margins between 6.5% and 7.0% (even with second-quarter guidance calling for achievable revenue of $59.5 billion-$63.5 billion and $2.6 billion-$3.6 billion in operating profit--or roughly 5.0% operating margins). Amazon remains one of our top investment ideas, and we're planning to increase our $2,200 fair value estimate as one-day shipping investments will be more than offset by new user engagement/subscription and seller monetization.

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About the Author

RJ Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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