Morningstar

Amazon Pullback an Opportunity

Revenue growth trends raise questions, but we still remain confident the wide-moat firm's longer-term disruption and free cash flow potential.

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Amazon.com Inc
(AMZN)

While skepticism about revenue growth trends have been dominating the headlines following the update and weighing on the stock, we still remain confident in wide-moat

Our five-year assumptions calling for 23% top-line growth and operating margins of 7%-8% remain in place. On revenue, we had always forecast some degree of natural deceleration, with our model calling for revenue to slow from the low 30s in 2018 to the mid-20s in 2019. We had factored in the lapping of the Whole Foods acquisition and the shift to third-party sales and subscription-based services. However, fourth-quarter revenue growth guidance of 10%-20% also reflects accounting changes for Prime memberships, foreign currency headwinds, and potentially some conservatism for holiday competition.

Continuing recent trends, Amazon blew away the high end of its operating profit target for the third quarter, delivering $3.7 billion (6.6% of revenue) versus its outlook for $1.4 billion-$2.4 billion. Amazon is ahead of schedule on the five drivers of margin expansion we've previously identified (AWS, Prime engagement/subscription services, third-party sales, advertising, and technology licensing). AWS engagement/cost-containment remains strong (as evidenced by segment margins of 31%), while Prime and other subscription platforms remain healthy even with the base-fee hike. Advertising is still Amazon's breakthrough story for 2018, and while management shied away from it, we see multiple ways to evolve this business in the future. Wage increases and potential USPS rate hikes lurk as margin headwinds, but we wouldn't be surprised to see Amazon reallocate some of its strong margins and invest in near-term retail growth.

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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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