Our key takeaway from wide-moat Amazon's (AMZN) fourth-quarter update wasn't so much that the core building blocks of our longer-margin cash flow assumptions are intact, but that new sources are also becoming contributors sooner than anticipated. The pillars that we've highlighted in the past all contributed to fourth-quarter results, including AWS (where revenue growth reaccelerated to 45% from 42% last quarter), Prime memberships (according to management, more new paid members joined Prime in 2017 than any previous year, both worldwide and in the U.S.), and third-party units (which grew 28% and represent 51% of total units). However, digging deeper, we believe that advertising (signified by the 62% increase in other revenue growth) and third-party seller services (which grew 41% and indicate strong Fulfillment by Amazon and other seller service adoption) were key contributors to the 140-basis-point jump in North American retail segment margins to 4.5%. Additionally, we believe Alexa technology (which continues to be integrated across a wide number of smart home and other technology-enabled devices) and new retail formats will join the list of monetization opportunities in the years to come.
We're planning to raise our fair value estimate from $1,250 per share to $1,600, with $75 of the increase attributed to time value of money, $100 due to a lower effective tax rate, and the remainder from more optimistic five-year revenue growth and margins estimates stemming from the aforementioned emergent cash flow drivers. Our model now assumes 21% average annual revenue growth from 2018 to 2022, including 26% growth from third-party seller services, 34% from retail subscription services, 38% from AWS, and 43% from other sources. While Amazon's growth will still require fulfillment, technology, and content investments, we see a path to 6% margins over the next five years (compared with 2.3% in 2017). Even after the post-fourth-quarter rally, we view shares as undervalued.
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R.J. Hottovy, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.