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Stock Analyst Update

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.


Even the most ardent  Amazon (AMZN) bear would have a hard time finding negatives from its second-quarter update, as Amazon Web Services, advertising services, third-party sales, and Prime memberships are each contributing to an increasingly visible long-term cash flow story.

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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R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.