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By R.J. Hottovy, CFA| 7-24-2018 10:00 AM

Why We Raised Amazon’s Fair Value

Second-quarter results provided more evidence than higher margins are achievable.

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Even the most ardent Amazon bear would have a hard time finding negatives from its second-quarter update, as Amazon Web Services, advertising services, third-party sales, and Prime memberships are each contributing to an increasingly visible long-term cash flow story.

With greater visibility for some of Amazon's highest-margin categories, we now think 8% operating margins are achievable over the next five years (assuming top-line growth in the low to mid-20s) and plan to raise our fair value estimate to $2,200 from $1,900. 

Accelerating revenue growth for web services is getting a lot of attention. However, we believe it's North American retail operations that should have investors' attention, as its network effect--the primary source behind our wide moat rating--is starting to manifest in more stable profitability.

As in previous quarters, we think advertising services are among the primary reasons Amazon continues to come in above its quarterly operating profit goals, reinforcing its importance as a distribution platform for sellers, which should continue over the foreseeable future.

We also think third-party sales and increased Prime member engagement are contributing to the margin upswing, which should persist through new logistics options for sellers while Prime members take advantage of new benefits like Whole Foods and Amazon Music, which have positive member pricing implications.

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