While skepticism about revenue growth trends have been dominating the headlines following the update and weighing on the stock, we still remain confident in wide-moat Amazon's (AMZN) longer-term disruption and free cash flow potential, and we view today's pullback as an opportunity. We're not planning material changes to our $2,200 fair value estimate, as some of the third-quarter upside will be offset by minor adjustments to our medium-term assumptions.
Our five-year assumptions calling for 23% top-line growth and operating margins of 7%-8% remain in place. On revenue, we had always forecast some degree of natural deceleration, with our model calling for revenue to slow from the low 30s in 2018 to the mid-20s in 2019. We had factored in the lapping of the Whole Foods acquisition and the shift to third-party sales and subscription-based services. However, fourth-quarter revenue growth guidance of 10%-20% also reflects accounting changes for Prime memberships, foreign currency headwinds, and potentially some conservatism for holiday competition.
Continuing recent trends, Amazon blew away the high end of its operating profit target for the third quarter, delivering $3.7 billion (6.6% of revenue) versus its outlook for $1.4 billion-$2.4 billion. Amazon is ahead of schedule on the five drivers of margin expansion we've previously identified (AWS, Prime engagement/subscription services, third-party sales, advertising, and technology licensing). AWS engagement/cost-containment remains strong (as evidenced by segment margins of 31%), while Prime and other subscription platforms remain healthy even with the base-fee hike. Advertising is still Amazon's breakthrough story for 2018, and while management shied away from it, we see multiple ways to evolve this business in the future. Wage increases and potential USPS rate hikes lurk as margin headwinds, but we wouldn't be surprised to see Amazon reallocate some of its strong margins and invest in near-term retail growth.
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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.