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Raising Our Amazon Fair Value Estimate

Amazon’s third-quarter results show that the company has one of the widest economic moats in the consumer space today, writes Morningstar’s R.J. Hottovy.

Some critics may point to a deceleration in North America margins (3.5% versus 5.1% last quarter, but also a 300-basis-point gain versus a year ago) and an international business that is still in the red. However, the third quarter is typically Amazon's weakest ahead of the holiday season. Based on gross margin gains (up 500 basis points to 33.9%) and current investment trends, we're comfortable calling for 200 basis points of North America operating margin improvement to 6% in the fourth quarter. Additionally, many international markets are starting to demonstrate Prime adoption and third-party sales trends consistent with the maturation curve in the United States, suggesting operating margins can build to the low- to mid-single-digit range over time.

Based on the strength of AWS (which appears well on its way to 30%-plus segment margins), greater confidence in North America segment profitability, and improving international margin visibility, we plan to raise our fair value estimate to $700 per share from $600. Our model previously assumed GAAP operating margins would grow to 6.5% by 2019, but we now believe 7.0%-plus is achievable. There is always a risk to these estimates if Amazon embarks on a major investment cycle, but we're comfortable with this risk, given recent capital discipline and investments more directly aligned with the core commerce and AWS platforms.

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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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