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Stock Analyst Update

One-Day Shipping Weighs on Amazon

The wide-moat firm remains our top pick in online retail, with the pullback offering an entry point to invest.

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Like last quarter, the cost of Prime One-Day shipping is the focal point of Amazon's (AMZN) third-quarter update, when we believe the market should be more focused on the revenue growth acceleration across many of its business segments. It's fair to ask whether Amazon's longer-term cash flow algorithm has changed with Prime One-Day, with fourth-quarter guidance for operating income of $1.2 billion-$2.9 billion versus $3.8 billion a year ago. While one-day shipping is costly, we ultimately believe it will strengthen Amazon's third-party seller offering while unlocking new subscription revenue opportunities. In our view, this will bolster the network effect behind our wide moat rating and keep Amazon on pace for high-single-digit operating margins the next five years.

It's clear that consumers are buying more on Amazon and vendors are using Amazon's logistics services to make this happen, with online retail revenue growth accelerating 6 points to 21% and third-party services revenue growth accelerating 4 points to 27%. Management confirmed that Prime members are increasing order frequency--including an acceleration in lower-average-selling-price products--and units shipped by Fulfillment by Amazon are accelerating under Prime One-Day. While management expects one-day shipping to result in a "$1.5 billion penalty" in the fourth quarter and operating margin contraction for 2019, we still believe the buyer/seller engagement will drive longer-term margin expansion while neutralizing competition from Walmart and others.

Amazon saw strong growth from its subscription services (34%), advertising (45%-plus), and Amazon Web Services (35%) segments. Taken together, we still see a path to high teens average annual revenue growth and operating margins exceeding 9% the next five years, and we plan to maintain our $2,300 fair value estimate. Amazon remains our top pick in online retail, with today's pullback offering an entry point to invest.

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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.