The just-closed acquisition of Whole Foods Market, Inc. (NASDAQ:WFM) by Amazon.com, Inc. (NASDAQ:AMZN) has created something close to a frenzy on Wall Street. Grocery stocks like Kroger Co (NYSE:KR) fell sharply on the merger announcement. They fell again last week when Amazon got to work cutting Whole Foods prices, with grocery stocks giving up a whopping $12 billion in market value in one day. The contagion has even spread to food producers, where some shares have weakened as investors fear increased discounting — and lower profits — across the industry.
Forgotten in that frenzy, however, has been an important fact. Whole Foods wasn’t performing all that well on its own. Same-store sales declined year-over-year for WFM’s last eight quarters as a standalone company.
Whole Foods was making some progress on a turnaround, one key reason I recommended buying the stock before the takeover by Amazon was announced. But the pessimism toward Whole Foods’ rivals seems to include something close to certainty that AMZN will improve those sales in a way that Whole Foods couldn’t on its own. And it’s worth considering if that necessarily will be the case.
How Much Is AMZN Cutting Prices, Really?
The Street is selling off grocery stocks because it fears that those grocers won’t be able to compete with Amazon’s pricing. Between the company’s supply chain advantages and its razor-thin margins, bears argue that pure grocers will have to cut prices to a point that may be unsustainable. Not only grocery stocks, but the bonds of the companies, have sold off as a result.
But it still remains to be seen just how much AMZN plans to cut prices at Whole Foods. Early reports are mixed as to whether Amazon is cutting prices across the board, or simply garnering headlines with targeted reductions on items like bananas and avocados. Whatever the early movements, Amazon no doubt will continue to tweak its pricing going forward, and more reductions are likely.
Regardless, the company may not have as much room to slash pricing as some observers suggest. In fiscal year 2016, Whole Foods’ operating margin was just 5.5%. Even assuming AMZN can find cost savings in the supply chain, it’s unlikely prices will come down double-digits across the board. For some shoppers, a 6%-8% price reduction might be enough to return to Whole Foods — and enough to get Whole Foods same-store sales turning positive again. But even that level of a pricing cut would require Amazon to give up most, if not all, of the chain’s profitability.
It will also take some time for Whole Foods to shed its “Whole Paycheck” reputation — no matter who owns it. Amazon’s reputation will help with some consumers, to be sure. But if Whole Foods’ new pricing isn’t enough to convince shoppers who have already moved on, the share gains many expect Whole Foods to make may not materialize.
What Amazon Can Do With Whole Foods
The fact is that Whole Foods probably isn’t going to be able to cut prices to make it a competitor to the US’ largest grocer, Wal-Mart Stores (NYSE:WMT). That’s just one of the reasons I recommended buying WMT stock on the AMZN stock dip in June. Indeed, WMT stock has rebounded since.
But Amazon will be able to make some changes to improve sales. Clearly investors are willing to forgive AMZN stock for low margins. That gives the company room to take down pricing across the board — perhaps even to the point of running losses, at least at first. And Whole Foods will provide other benefits for Amazon stock.
AMZN lockers can be added to Whole Foods locations, providing another boost to the dominant e-commerce business. Whole Foods stores already are selling the Amazon Echo, as Amazon looks to strengthen its market share lead in “smart speakers”.
As the company takes control of Whole Foods, the potential benefits for the company, and AMZN stock, are clear. Amazon should be able to improve pricing, and in a best-case scenario bring back lost Whole Foods customers. And having a fleet of 470 brick-and-mortar stores in the United States and United Kingdom will provide a further complement to the existing online business.
The Whole Foods acquisition, on its own, doesn’t make or break Amazon stock. It will take time for Jeff Bezos and AMZN to fully put their imprint on the grocer. But it’s clearly another step in the evolution of Amazon from being dominant in e-commerce to being dominant across retail.
It’s another good reason to go long AMZN stock.
Hilary Kramer is the editor of GameChangers, Breakout Stocks, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
