Groceries Are a Rotten Business

The Safeway-Albertsons merger is just a red herring -- the real story in the grocery space is about nontraditional grocers

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Groceries Are a Rotten Business

Something sends a chill down the spine of a traditional retailer than hearing the name “Amazon (AMZN).” Amazon has taken a wrecking ball to every market it has entered, essentially putting Borders out of business giving Best Buy (BBY) a thorough beating.

Well, Amazon also has joined the grocery fray as well via its Amazon Food site, which sells packaged foods, and its newer Amazon Fresh, which offers fresh produce delivered to your door in a limited number of markets. AMZN encourages a subscription model whereby shoppers get certain common items — say, a two-liter bottle of Coke — delivered at a regular interval.

Not to be outdone, Walmart has jumped into online groceries as well. In addition to offering free home delivery on orders $50 and up (Amazon offers free delivery on orders $35 and up), WMT has the added bonus of offering free in-store pickup at its massive network of stores. Walmart does not deliver perishables or fresh produce — yet. But you can bet that it’s studying Amazon’s moves closely.

Albertson’s, Safeway and Kroger all also offer some limited form on online shopping or delivery, though it varies by geography.

Online groceries were an unmitigated disaster when the concept was first tried in the late 1990s. Remember HomeGrocer.com and Webvan? You probably don’t, and there is a reason for that. Neither survived the 2000-02 shakeout. It was a business model ahead of its time.

Granted, Americans are a lot more web-savvy than they were 10 years ago and have grown more accustomed to paying for delivery. And AMZN and WMT are established retail empires with massive infrastructure in place, not fledgling startups.

Still, outside of major urban areas with high population density — think New York or San Francisco — or among high-income Americans that are insensitive to price, we’re probably at least five to 10 years away from home grocery delivery being mainstream.

Why? Because groceries, again, are a low-margin business, and delivery operations are expensive to maintain — particularly in cities with sprawling suburbs like Los Angeles, Houston, or Dallas.

There Are Winners … Just Not Traditional Grocers

So, in the meantime, where are the pockets of opportunity?

As a business, I consider Whole Foods to have the best prospects of the lot and best potential for growth. But WFM is only slightly more profitable than Walmart and sports a frothy P/E ratio that is more than double the industry average. I love Whole Foods as a company. But I can’t get comfortable with the exorbitant price of WFM stock.

I would argue the same for Amazon. Amazon is an amazing company, and Jeff Bezos is a CEO that I respect. But Bezos’ focus on revenue growth at the expense of all else has left the company barely profitable, and it sports the lowest return on assets in the sector. Also, AMZN stock is more than four times as expensive as WMT on a price/sales basis (2.28 vs. 0.51, respectively).

If I’m buying any grocer, it’s going to be Walmart. It has a scale that none of its competitors can match, has the highest profitability of the mass-market grocers, and offers a very reasonable valuation at 15 times trailing earnings and 13 times forward earnings. WMT has also been aggressively shrinking its share count and raising its dividend.

And before you write Walmart off as a retail dinosaur, consider that WMT has a division situated in the center of Silicon Valley — Walmart ECommerce — that is staffed with 1,500 techies whose job is to find ways to fight Amazon on its own turf.

Will Walmart catch up to Amazon in terms of sales growth any time soon? No, not realistically. But they also have a massive international logistical operation in place that Amazon is still trying to build. And frankly, no one on Wall Street expects much from WMT these days, so any surprise in performance is likely to send the shares sharply higher.

As for traditional grocery stores, I would stay out of this space. Realistically, they cannot compete with the likes of Walmart or Amazon, and they lack the scale to make home delivery work. I’m not forecasting a wave of bankruptcies any time soon, but not much in the way of profitability either.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long WMT. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.


Article printed from InvestorPlace Media, http://investorplace.com/2014/03/groceries-wmt-amzn-wfm/.

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