The e-commerce giant agreed last month to acquire high-end grocer Whole Foods for $13.7 billion. The market developed a consensus belief rather quickly. Amazon would leverage its Prime ecosystem to cut traditionally sky-high Whole Foods prices for Prime customers. By doing so, Amazon would offer Whole Foods goods at Wal-Mart Stores Inc (NYSE:WMT) prices.
Amazon wins because that price war would ensure market share gains for WFM while simultaneously growing the very valuable Amazon Prime member pool. Every other grocer loses because, as a good many retailers can already tell you, price competing with Amazon is a battle you just won’t win.
But maybe the market should take a pause on that train of thought. After all, investors rushed to those conclusions rather quickly despite Whole Foods recent struggles in the grocery space.
Today, Whole Foods released third-quarter results, and not in a pretty manner. The company released the results earlier than expected, dropped some comparable-store sales figures, provided no guidance and said it would not be hosting a conference call due to the acquisition.
Amazon clearly didn’t buy a flawless product.
Whole Foods Is Struggling
Whole Foods was once the best growth story in the entire grocery world. Comparable-store sales were rising in the high single-digit range. Sales were booming. Margins were growing. But that was several years ago (pre-2013) when health eating trends were just coming to the forefront.
That trend seems to have somewhat overshot itself.
Yes, consumers are still heavily concerned about health habits, but they also don’t want to compromise on price. Just look at the comeback McDonald’s Corporation (NYSE:MCD) has made over the past year. Once slammed for horribly unhealthy food, MCD is now winning consumers over again … and not because of healthier options.
The same thing is playing out in the grocery world. WFM missed the boat on trying to overlap health and price. They kept prices high, assuming that consumers would still choose healthy food over unhealthy food regardless of price. They were dead wrong. And worse, Walmart and other grocers got into the organic game at lower prices, showing that Whole Foods wasn’t necessarily bringing everyone in on brand name alone.
Eight quarters ago, comps fell into negative territory. They haven’t been positive since. The negative trend continued today, when WFM announced comparable store sales fell 1.9% in Q3.
Admittedly, the report wasn’t all ugly. Revenues and adjusted earnings both beat, though net income dropped 11.7% to $106 million, and sales only fractionally improved to $3.73 billion.
Presumably, Amazon can help Whole Foods compete better on price while still running a profitable business. But getting there — which likely could include a deep re-branding — clearly will be a process.
A Good Thing for Low-Price Grocers
Walmart and Target have moved heavily into groceries over the past decade, but more recently have pioneered the “mass-market organics” space, which is simply offering normally expensive organic foods at more reasonable prices. Meanwhile, Costco has always offered some of the lowest grocery prices on the market thanks to its unique business model.
Many investors sold off WMT, TGT and COST in the wake of the Amazon-Whole Foods deal because they drew in customers with their low prices. But that fear may be overstated. Whole Foods still has a very real problem that Amazon must solve — getting Whole Foods to the sweet zone where price-conscious consumers are happy, but so are the upper-scale health-conscious consumers that WFM long targeted.
Make no mistake: Amazon scored a win when it bought out Whole Foods. But going from assumed dominance to actual dominance might take longer than Wall Street thought.
As of this writing, Luke Lango was long AMZN, COST, TGT and WMT.