Amazon's Drivers Are Built to Last

Amazon's core retail profit functions--which we consider to be third-party seller services and retail subscriptions--accelerated to 44% and 60% growth, respectively. While both line items saw modest benefit from revenue recognition accounting changes, they contributed to the 260-basis-point increase in gross margins to 39.8% and 90 basis points of improvement in North America segment margins to 3.7%. With CEO Jeff Bezos' recent shareholder letter highlighting the strong growth in small/medium businesses sellers (including 300,000 new sellers last year) and the announcement that U.S. Prime membership base prices will increase to $119 from $99 beginning in May, we believe both of these revenue streams will remain healthy in the years to come.

Outside of the core drivers, we're seeing strong contribution from emergent drivers such as advertising (which helped other revenue grow an impressive 72% year over year after adjusting for accounting changes and was called out as a key margin driver), subscription services like Amazon Music and Kindle Unlimited, and international retail (up 21% excluding foreign currency) where we're seeing a ramp in Prime memberships comparable to the U.S. between 2010-15. On top of the retail contributors, AWS posted accelerating revenue growth (49%) and margin gains (up 140 basis points to 25.7%), indicating that the business unit is managing competition from Google and Microsoft Azure.

We're tentatively planning to raise our fair value estimate to $1,900 from $1,600, with the bulk of the increase coming from more optimistic near-term revenue assumptions stemming from the various drivers. Even after the post first-quarter rally, we view shares as modestly undervalued.

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