Amazon's Long-Term Margin Story Intact
Despite fulfillment and content investments, we have no plans to change our $900 fair value estimate.
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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