We are raising our fair value estimate for wide-moat Amazon AMZN to $200 per share from $195 after the company reported solid third-quarter results. The firm’s fourth-quarter outlook was generally aligned with our estimates. Changes to our model are minor but center around continued near-term profitability improvements. Overall results are pretty consistent with recent quarters. Amazon continues to gain efficiencies throughout the network, which helps lower costs and improve delivery speeds and ultimately drives increased purchases by prime members. We now see shares as fairly valued, after a strong run since early August.
Retail demand trends remain unchanged over the last 18 months, with e-commerce performing well but showing signs of consumer stress. Third-quarter revenue grew 11% year over year, as reported to $158.9 billion, compared with the top end of guidance at $158.5 billion. Relative to our estimates, online stores, subscription services, and AWS performed best, while third-party seller services and advertising modestly lagged. The two key segments for long-term growth, AWS and advertising, both expanded 19% year over year, as reported. Amazon‘s advertising growth continues to outpace its large internet peers, while AWS’s growth accelerated sequentially for the fifth straight quarter.
Margins have been consistently stronger than anticipated over the past year or two, and we continue to believe there is room for expansion as the multihub strategy continues to unlock efficiencies. Third-quarter profitability was outstanding, with operating profit at $17.4 billion, compared with the high end of guidance at $15.0 billion. This resulted in an operating margin of 11.0%, compared with 7.8% a year ago. Management’s long-term goal is to have international operating margins equal to North American margins. International posted positive operating profits for the third straight quarter, which is a positive indicator in our view. AWS profitability was very strong.
Guidance Broadly in Line
We consider guidance to be in line even as the revenue outlook was slightly light while profitability was slightly better than our expectations. The outlook is consistent with our longer-term thinking of gradually decelerating revenue and gradually ramping margins. Amazon’s fourth-quarter outlook includes revenue of $181.5 billion to $188.5 billion and operating income of $16.0 billion to $20.0 billion. Guidance includes a negligible currency effect of a 10 basis point headwind to growth. 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, offering lower prices, and improving delivery speed. These factors continue to drive order frequency and ticket sizes for prime members. We see continued expansion of the same delivery as a margin lever, and we look forward to hearing more about how robotics and automation are lowering costs in the company’s brand-new facility in Shreveport, Louisiana. Management noted that consumers continue to focus more on everyday items, trade down, and seek deals while eschewing larger ticket discretionary items. Paid unit growth was 11% year over year, buttressing the consumer trade-down narrative. This is unsurprising and still represents the underpinnings of our near-term estimates. From a retail sales perspective, revenue from online stores increased 7%, physical stores increased 5%, third party increased 10%, and subscription services increased 11% (all year over year, as reported).
GenAI, Cloud Growth Boost AWS
AWS is clearly benefiting from a shift back to porting new workloads to the cloud and the generative AI boom. 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 that is growing revenue in the triple digits and growing three times faster than AWS was in its infancy. Management also confirmed that AWS is capacity-constrained for generative AI usage. We think each of these trends is directionally similar to Microsoft’s Azure business, and that AWS is set up well for durable growth over the next couple of years. Third-quarter AWS revenue growth accelerated to 19% year-over-year growth to $27.5 billion, compared with 19% growth last quarter and 12% a year ago.
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 and through 2025, which is consistent with our model and competitors’ plans.
Amazon’s profitability improvements have been impressive, and we continue to think additional enhancements are likely. In retail, the regional hub model has yielded both cost savings and improved delivery speeds. Management continues to methodically ratchet up efficiencies throughout the network, most recently on inbound improvements and the opening of a next-gen automated facility with increased use of robotics. Strength in high-margin business AWS also continues to bolster profitability.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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