Acceleration Across Amazon's Services Portfolio

Posting another quarter of exceptional growth (revenue of $96.2 billion, up 37.4%, versus guidance of $87-$93 billion) and profitability (operating profit of $6.2 billion, representing operating margins of 6.4%--10.0% excluding $3.5 billion in COVID-related expenses--versus guidance of $2-$5 billion), the natural question investors might be asking is how much of wide-moat Amazon's AMZN recent momentum is tied to pandemic demand and how much reflects structural changes? While certain trends are unlikely to repeat--pantry stuffing and fulfillment centers running at elevated capacity, for instance--many changes in consumer behavior are likely to sustain, giving us confidence in our five-year targets calling for 22% top line CAGR and 10% operating margins.

Our conviction comes from several service-related sources. One, Prime member engagement remains high, with Prime member renewal rates improving year over year and subscription revenue per Prime member increasing roughly 10% according to our estimates. Two, third-party seller services revenue also accelerated (55% from 52% last quarter), which not only indicates Amazon's importance as a distribution channel, but that sellers are increasingly using services like Fulfillment by Amazon (FBA). Three, as advertising budgets rebound from COVID lows, we expect Amazon will become an increasingly important partner both on and off Amazon marketplaces. Four, while demand remains mixed among some customers in discretionary categories, AWS margins (up 530 basis points to 30.5%) reinforces our views existing AWS users are graduating to more value-add services. Lastly, while the firm noted international profitability is "running ahead of schedule" because of fulfillment capacity usage, we still see a path to mid-single-digit operating margins for many markets outside the U.S.

We're planning to raise our $3,500 fair value estimate by a few percentage points to account for this quarter's upside and see shares as modestly undervalued.

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