Shipping Investments Hit Amazon Margins
We view Amazon as one of the most attractive names in online commerce.
While much of the focus coming out of Amazon's AMZN second-quarter update is on its softer-than-expected third-quarter operating income guidance--a range of $2.1 billion-$3.1 billion, down from $3.7 billion a year ago due to one-day free shipping investments--we believe the real story from the quarter was revenue acceleration from Amazon's online retail, third-party seller services, and advertising segments, indicating that the network effect underpinning its wide moat is intact, as is the foundation for more profitable growth.
Admittedly, one of the more interesting developments from Amazon's expanded Prime one-day shipping was the increase in lower average selling price, or ASP, products in the mix as "more products enter (consumers') consideration set" with faster shipping. While some investors will point out the potential margin hit that could come with increased shipping costs on lower-priced products--and we certainly think that played a role in this quarter's 80-basis-point decrease in operating margins to 4.9%--we think the longer-term vendor and buyer engagement benefits are more significant. For the quarter, management noted that its one-day shipping investments exceeded $800 million (1.3% of second-quarter revenue) and that continued one-day delivery investments were the primary reason that third-quarter operating profit would likely decline year over year. However, we think that these investments will facilitate better engagement with consumers (increased order frequency allows Prime members to evaluate higher-margin subscription offerings) and make its marketplaces a more vital channel for vendors (unlocking future monetization opportunities).
There is no change to our $2,300 fair value estimate, and we still view Amazon as one of the most attractive names in online commerce. It's possible that one-day shipping investments will weigh on the stock in the near term, but we believe the top-line benefits will become apparent as the year progresses.
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