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Amazon's Near-Term Margin Profile Changes

Coronavirus-related investments change the wide-moat company's near-term margin profile, but also bolster network effect.

While most investors recognized the possibility of incremental costs to satisfy a surge in consumer demand, few anticipated Amazon's AMZN plans to invest more than $4 billion in the second quarter for coronavirus expenses (including facility productivity measures, protective equipment, cleaning, wage increases, and COVID-19 testing capabilities). While this changes our near-term margin outlook, we see it as necessary to satisfy/retain Prime members in an evolving consumer environment (especially those tempted to shop elsewhere because of fulfillment bottlenecks) and improve the third-party seller experience. These are critical to the network effect underpinning our wide-moat rating and justify the investment spending.

We have three takeaways from the quarter. First, management indicated many COVID-19-related investments would be temporary and would wind down as the situation dictates. While we expect COVID-19 investments to persist beyond the second quarter, some of the impact will be softened as Amazon laps last year's Prime one-day shipping investments. Second, Amazon should remain a critical distribution channel for buyers/sellers, even if recessionary conditions persist because of a product mix shift toward consumer staples in recent years (including grocery). Third, while AWS revenue growth was a bit softer than expected (chalked up to softness among customers in higher discretionary categories), margins improved 120 basis points to 30.1%. This suggests increased usage and new service adoption trends among existing customers, which help to negate the margin impact of near-term COVID-19 investments.

We're planning to raise our full-year revenue growth outlook to the mid-20s but cut our operating margin outlook to the 4% range (versus 5.2% in 2019). We're also planning a modest increase in our medium-term revenue outlook, which will result in a modest increase to our $2,400 FVE. We see shares as fairly valued, but don't see many downside catalysts on the horizon.

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About the Author

RJ Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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