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Amazon Looks Undervalued

We’re boosting our view of Amazon’s growth potential and fair value estimate after earnings.

Sales for Amazon's North America e-commerce segment accelerated to 28%--the highest quarterly growth rate since the third quarter of 2013--demonstrating Amazon's importance as a distribution channel and reinforcing the network effect behind our wide moat rating. More important, we believe the operating leverage in Amazon's model is becoming increasingly apparent, evidenced by segment-level margins of 6.5% (4% including stock-based compensation). The flywheel created by Prime memberships and third-party sellers is also evident in Amazon's international segment, where electronics and general merchandise sales--which most closely track Prime membership growth, in our view--were up an impressive 38%. While the international segment is running at nominal profitability, we're comfortable with the investments Amazon is making overseas--including India, which we view as one of Amazon's highest-potential markets--based on Prime membership and third-party sellers in these regions, and we expect a more apparent margin story to emerge in the future. Finally, AWS' top-line growth of 58% and 30% segment margins (25% including stock-based compensation) continue to reinforce that this is much more than commoditized cloud storage business.

On the basis of the impressive top-line trends, Prime accelerating overseas, and an expanding AWS customer base, we're increasing our five-year average annual revenue growth target to 19% from 16%. We will leave in place our outlook for GAAP operating margins of 7.5% by 2020, but the more optimistic top-line forecast will move our fair value estimate to $900 from $800, suggesting that the shares are undervalued.

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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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