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Amazon's New Opportunities in Coronavirus; FVE to $3500

Following a paradigm-shifting update from Amazon, we raise our five-year average annual revenue outlook to 22% from 19% and our five-year operating margin target to 10% from 8%. We increase our fair value estimate to $3,500 per share

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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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About the Author

R.J. 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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