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The Four Pillars Driving Amazon’s Success

We’re boosting our fair value estimate for Amazon as advertising, AWS, Prime and third-party sales are each contributing to an increasingly visible long-term cash flow story.

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Amazon.com Inc
(AMZN)

Even the most ardent

AWS is getting a lot of attention, with revenue growth accelerating for the third straight quarter to 48.9% and segment margins improving 460 basis points to 26.9% due to operating leverage from strong customer usage rates. However, we believe it's North American retail operations that should have investors' attention, as its network effect--the primary source behind our wide moat rating--is starting to manifest in more stable profitability.

As in previous quarters, we think advertising services are among the primary reasons Amazon continues to come in above its quarterly operating profit goals ($3.0 billion this quarter--5.6% of sales--versus guidance of $1.1 billion-$1.9 billion), reinforcing its importance as a distribution platform for sellers, which should continue over the foreseeable future.

We also think third-party sales and increased Prime member engagement are contributing to the margin upswing, which should persist through new logistics options for sellers while Prime members take advantage of new benefits like Whole Foods and Amazon Music, which have positive member pricing implications.

With greater visibility for some of Amazon's highest-margin categories, we now think 8% operating margins are achievable over the next five years (assuming top-line growth in the low to mid-20s) and plan to raise our fair value estimate to $2,200 from $1,900.

While Amazon's third quarter typically carries the greatest downside risk due to fulfillment center investments ahead of the holiday season, we think advertising, AWS, and other contributors should mitigate this risk and make third-quarter targets ($54.0 billion-$57.5 billion in revenue, $1.4 billion-$2.4 billion in operating income) achievable.

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About the Author

R.J. 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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