Amazon on Offense, Defense With 1-Day Shipping
We're planning to increase our $2,200 fair value estimate for the wide-moat firm.
Amazon's AMZN first-quarter update reinforced its continued shift in to a more dynamic free cash story, with subscription platforms, AWS, advertising, and Whole Foods each contributing to strong revenue growth ($59.7 billion--near the high end of guidance calling for $56 billion-$60 billion) and a new high-water mark for first-quarter operating margins (7.4% versus 3.8% a year ago). Nevertheless, it was Amazon's announcement that it plans to evolve its Prime two-day free shipping program into a one-day free shipping program that warrants the closest examination.
We see both a defensive and offensive rationale behind the one-day shipping decision. From a defensive perspective, we believe competitors such as Walmart, Target, and Best Buy have steadily been narrowing the delivery speed gap with Amazon the past 12-18 months, but we believe this move will help to reinforce the network effect component behind out wide-moat rating (with one-day delivery appealing to not only buyers, but also sellers). On the offensive front, we believe expanded one-day delivery capabilities (which will necessitate $800 million of incremental investment in the second quarter and additional investment as the year progresses) will create new third-party seller monetization opportunities and unlock new subscription service offerings, both of which are central to our longer-term assumptions.
Although Amazon plans to ramp up fulfillment and head count investments as the year progresses, we believe AWS, advertising, and subscription offerings can drive full-year margins between 6.5% and 7.0% (even with second-quarter guidance calling for achievable revenue of $59.5 billion-$63.5 billion and $2.6 billion-$3.6 billion in operating profit--or roughly 5.0% operating margins). Amazon remains one of our top investment ideas, and we're planning to increase our $2,200 fair value estimate as one-day shipping investments will be more than offset by new user engagement/subscription and seller monetization.
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