Key Morningstar metrics for Amazon

  • Fair Value Estimate: $195.00
  • Morningstar Rating: 4 stars
  • Morningstar Economic Moat Rating: Wide
  • Morningstar Uncertainty Rating: High

What we thought of Amazon’s earnings

We are raising our fair value estimate for wide-moat Amazon (NAS: AMZN) to $195 per share from $193 after the company reported solid second-quarter results. The company’s third-quarter outlook aligned with our revenue estimate and was better than our operating income estimate. Changes to our model are modest but center on continued profitability enhancements in the near term. Amazon continues to take strides in efficiency

improvements throughout the network, which helps lower costs and improve delivery speeds, ultimately driving increased purchases by Prime members. After a pullback that began in early July, we see shares as increasingly attractive.

Overall demand trends remain unchanged over the last year or so, with e-commerce showing signs of consumer stress. Second-quarter revenue grew 10% year-over-year as reported, or 11% in constant currency, to $148.0 billion, compared with the guidance mid-point of $146.5 billion. Relative to our estimates, online stores and third-party seller services drove most of the miss, while all segments were slightly light. Amazon Web Services was nicely ahead of our model. The two key segments for long-term growth, AWS and advertising, increased 19% and 20% year over year, as reported, respectively. Amazon’s advertising growth continues to outpace its large internet peers, while AWS’ growth accelerated sequentially for the fourth straight quarter.

Margins have been consistently stronger than anticipated over the past year, and we continue to believe there is room for expansion as the multihub strategy continues to unlock efficiencies. Second-quarter profitability was impressive, with operating profit at $14.7 billion, compared with the high end of guidance at $14.0 billion. This resulted in an operating margin of 9.9%, compared with 5.7% a year ago. The international unit generated positive operating profits for the second straight quarter, which we think is a harbinger for longer-term expansion.

Amazon outlook in line with estimates

While mixed compared with our estimates, we see Amazon’s third-quarter guidance as in line, although we note that consensus had contemplated better profitability than our model. We think the outlook is consistent with our longer-term thinking but is helping drive shares lower in the after-market. The firm’s third-quarter outlook includes revenue of $154.0 billion- $158.5 billion and operating income of $11.5 billion-$15.0 billion. Note that guidance includes 90 basis points of currency headwind, which is worse than we previously contemplated, making the revenue outlook better than it appears at first blush.

Our previous aggressive revenue estimate was in line with the high end of guidance, while our previous estimate for operating profit was about $1 billion shy of the midpoint of guidance. After allowing for an upside in the quarter and smoothing various expense lines over the next year or so, we raised our fair value estimate modestly. We see a path to continuous margin improvement over time, even if these gains do not come in a linear fashion.

On the retail side, Amazon continues to target the overall customer experience by expanding its selection and improving delivery speed. These factors continue to drive order frequency and ticket sizes for Prime members. Management reiterated it can continue to improve selection and delivery speed while improving margins, which we think has been fairly evident over the last year. The company confirmed that consumers continue to trade down, seek deals, and focus more on everyday items while eschewing larger ticket discretionary items. This is unsurprising and still represents the underpinnings of our near-term estimates. From a retail sales perspective, revenue from online stores increased 5%, physical stores increased 4%, third parties increased 12%, and subscription services increased 10% (all year over year, as reported). Paid unit growth accelerated to 12% year over year, buttressing the consumer trade-down narrative.

AWS has shifted back to growth mode after the optimization efforts by clients have ended, and artificial intelligence has captured the customers’ attention. We think these trends are consistent with our expectation that AWS is an overall key long-term driver for Amazon. Management noted a multibillion book of business from generative AI already. More importantly, customers have returned to migrating new workloads to the cloud. Management comments are consistent with recent remarks from Microsoft regarding its Azure business, and we think it bodes well for growth through 2026. Second-quarter AWS revenue growth accelerated to 19% year-over-year growth to $26.3 billion, compared with 17% growth last quarter and 12% a year ago. AWS backlog was $156.5 billion and grew 19% year over year in the quarter. The fact that backlog is bigger than revenue and is growing faster gives us confidence over the next several years.

Amazon investing in data centres for AI

We believe Amazon is well-positioned in generative AI and should benefit as the technology adoption gains steam. We think the company’s proprietary chips, Trainium and Inferentia, and Bedrock and other AI-related solutions, support this notion. Management believes generative AI can add tens of billions of dollars to revenue over the next several years. On AWS overall, we think the migration to the public cloud is an enormous opportunity and remains in the early stages of evolution, with AWS being the clear leader. Based on strong AI demand, Amazon plans to increase capital investments in data center capacity in the second half of the year, when it expects capital expenditures to exceed $32.5 billion from the first six months of the year. This is consistent with our model.

Amazon’s profitability improvements have been impressive, and we continue to think there is room for further improvements. In retail, the regional hub model has yielded both cost savings and improved delivery speeds. Management has already identified improvements, including inbound improvements and increased use of robotics, that can be made to the regional hubs, even as it continues to attack other margin improvement vectors. We also note that more immediately, shipping rates, fuel prices, and a more rational labor environment contributed to margin upside in the quarter. Strength in high-margin businesses like advertising and AWS have boosted margins. They should continue to do so in 2024 and beyond as ads make their way into Amazon’s streaming portfolio and AWS continues to outgrow the retail business.

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