Morningstar

Amazon's Long-Term Margin Story Intact

Despite fulfillment and content investments, we have no plans to change our $900 fair value estimate.

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Amazon.com Inc
(AMZN)

Heading into

However, the second area of focus is less clear: 18 fulfillment center openings in the quarter (and five more in October), as well as digital content, Alexa/Echo, India, and AWS investments, drove operating income that fell short of expectations ($575 million--just 1.8% of revenue--versus market estimates of $670 million) and a softer-than-anticipated fourth-quarter outlook ($0-$1.25 billion, versus market estimates of $1.7 billion). While these investments are likely to reignite concerns about Amazon's longer-term cash flow potential, we believe all of these investment areas strengthen Amazon's ecosystem, laying the foundation for future margin expansion. With so many retailers and consumer brands utilizing FBA this holiday, we view the fulfillment center investments (as well as pricing/inventory storage changes designed to minimize last holiday's bottlenecks) as necessary, and we expect Amazon to exceed its fourth-quarter operating income outlook.

We plan to trim our 2016 operating margin outlook to 3% from 4%, but remain comfortable with our five-year outlook calling for 7% margins based on AWS operating margin gains (up 610 basis points to 26.6% in the quarter), FBA demand, and new Prime memberships and pricing tiers. With the addition of an uptick in our medium-term revenue assumptions via nascent opportunities like Alexa, we're not planning changes to our $900 fair value estimate, and we believe today's pullback could present an opportunistic entry point.

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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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