There was little doubt that Amazon (AMZN) was going to report a surge in coronavirus-related sales growth during second quarter, but the magnitude of the sales outperformance ($88.9 billion dollars in revenue, up 40%, versus guidance of $75-$81 billion) and operating profit upside ($5.8 billion versus guidance of negative $1.5 billion to $1.5 billion) make this a paradigm-shifting update.
It's hard to pin down the most impressive part of Amazon's results. Online sales growth accelerated to 48% from 24% growth last quarter, driven by new Prime memberships (U.S. and abroad) and a sharp uptick in sales per existing member (including online grocery sales, which tripled year over year). Third-party seller services also accelerated (52% from 30% last quarter), indicating that Amazon is becoming an even more vital channel of distribution. The international segment posted its first quarter of positive GAAP operating profit since 2011, with Prime flywheel setting up many markets for accelerating margins. AWS revenue declined (29% versus 33% last quarter), but strong segment margins (up 580 basis points to 31.1%) confirms that existing customers are ramping up value-add services.
However, operating margins of 6.6% (11% when stripping out $4 billion in COVID-19-related costs) was the most exceptional number from the update and represents a game changer for profitability. We had been skeptical that double-digit operating margins would be possible for Amazon, and at the very least, it would take several years to achieve due to capacity and other investments. However, third-party services, subscriptions, AWS, and international scale make this a more palatable medium-term target, with advertising and technology licensing (including Zoox) contributing longer-term.
We raise our five-year average annual revenue outlook to 22% from 19% and our five-year operating margin target to 10% from 8%. This will bring our fair value estimate to $3,500 per share, and we see shares as undervalued.
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