Morningstar

Amazon Shares Undervalued; Rising Profitability Key

Strong gross margins in the fourth quarter boost our confidence that the firm will be able to leverage Prime, third-party sales and AWS to higher margins in the years to come.

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Amazon.com Inc
(AMZN)

Our view of

While critics might point to revenue growth of 22% versus guidance of 17%-27% as a concern, we believe the growth rate is encouraging after stripping out a $558 million negative foreign currency headwind and accounting for the ongoing shift to third-party units sold (where Amazon records just a commission on the sale). Paid unit growth of 24% was a deceleration from the 28% averaged in the first three quarters of the year, but we attribute the difference to lapping last year's strong holiday demand among Fulfillment by Amazon sellers (which continued throughout the year--evidenced by the 70% increase in FBA sellers this year--and reinforces the network effect behind our wide moat rating).

We plan to increase our fair value estimate to $950 per share from $900 based on time value of money adjustments, and we encourage investors to take advantage of any weakness following the fourth-quarter update. With greater confidence in Prime, Amazon's third-party capabilities, and AWS coming out of the quarter--not to mention Alexa coming into its own as a unique long-term cash flow driver--we're comfortable with our outlook for operating margins to grow to almost 8% by 2021 from 3.1% in 2016.

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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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