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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.

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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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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