With Amazon.com (NASDAQ:AMZN) announcing an agreement to purchase Whole Foods Market (NYSE: WFM), the market is lauding Amazon and punishing nearly every other brick and mortar retailer. I for one am going to stand up and suggest that this reaction is absolutely ridiculous. The fact that Amazon.com decided that it needs a brick and mortar platform clearly tells us that brick and mortar retail is essential to retail. The reality is that most existing brick and mortar retailers including Kroger(NYSE: KR), Wal-Mart (NYSE: WMT), and Target (NYSE:TGT) not only have the existing real estate footprint that allows them to offer anything that Amazon.com can offer, but they also have tens of billions of dollars of profits annually that will assure their relevance going forward. I think we may be reaching "Peak Amazon", or the point at which the Amazon bulls have reached maximum confidence that Amazon will conquer the entire retail world. I believe Kroger (KR), Wal-Mart (NYSE:WMT), and Target (TGT) are fantastic investment opportunities right here, right now.
Let's begin by reminding readers that Whole Foods has seen declining net and operating income for years. Comp sales at Whole Foods have been negative for almost two years. Meanwhile, Kroger and Wal-Mart have been seeing growth, with analysts clearly pointing out that Kroger has stolen millions of customers directly from Whole Foods as they go after the natural and organic market. How quickly people have forgotten that this is reality and now all of a sudden Kroger and others are being priced by the market as if they are going to crumble at the hands of Amazon.com and Whole Foods.
No offense intended, but Seeking Alpha contributor "The Value Investor" claims in a recent article that Amazon could be able to capture $200-$300 billion of grocery sales in the next decade, with operating income around $10 billion annually coming from those grocery sales. The truth is that for Amazon/Whole Foods to achieve this level of sales and operating income they would need to grow at a compounded annual rate of around 30% for the next decade. Forgive me for being so blunt, but this is ludicrous, especially considering that the foundation for this growth is Whole Foods, which is literally facing declining income and negative comp sales as we speak.
Ultimately, the flaw in Amazon bull's thinking is not that the company isn't impressive, but rather that Amazon's stock is priced for perfection. Even if a decade from now Amazon.com has tens of billions of dollars of net income, they will need that simply to justify their CURRENT stock price. The question for Amazon investors should be, how do they make money going forward if everything already has to go right in order for them to justify their current stock price?
Regarding the brick and mortar stores that are now widely expected to suffer because of Amazon's purchase of Whole Foods, I would ask this question: Why is it that brick and mortar, which has been presumed to be dying for years now, is so essential to Amazon that they had to spend $14 billion of cash to acquire a grocery store chain? Up until now it was claimed that Amazon was going to destroy brick and mortar retail. Drones are supposed to be delivering things to Amazon Prime customers in an hour or two, leaving brick and mortar retail in the dust. I would flip the entire thesis around and claim that Wal-Mart, Kroger, Target, and others are already way ahead of Amazon simply because they have physical real estate within a few miles of nearly everyone in America. It is this footprint, combined with the giant cash flow that is associated with their existing stores, that gives them a lot more of an advantage than investors give them credit for.
Target and Wal-Mart have both been reducing inventory levels. Target has new technology that is so advanced that their distribution centers are sending stores exactly the amount of inventory that is needed to replace sold inventory. If a customer purchases a single bottle of shampoo, the nearest Target distribution center will send one bottle of shampoo to the store on the next truck. This has opened up huge amounts of back stock area, allowing it to be used to fulfill online orders directly out of stores. There is no reason that Target cannot ship from their stores to customers in a matter of hours. In fact, they already talk about doing this on conference calls.
Wal-Mart is testing all kinds of e-commerce initiatives, ranging from having employees delivering e-commerce orders on their way home from work, to offering discounts to customers who purchase online but pick up in store. Wal-Mart also has acquired Jet.com and a handful of other e-commerce retailers and, to the surprise of many, Wal-Mart is now expected to show a greater e-commerce sales growth rate than Amazon this year. And Wal-Mart has a staggering amount of cash flow, with cash from operations exceeding $31 billion last year alone. With this type of cash flow, Wal-Mart can acquire, invest in price, and invest in technology, doing whatever is necessary to make sure they are the winner in this war.
Kroger, along with Wal-Mart, is the king of grocery world, and Kroger practically invented the price war. If you go back to the early 2000s, you can see that Kroger's gross margins were once much higher than they are today. Kroger has invested billions into lower prices in order to win customers, and they have done very well over the years with sales, profits, and cash flow ramping up year after year. Kroger's Simple Truth brand hit $1.7 billion in sales alone last year and is a key part of Kroger stealing millions of customers from Whole Foods. And let's not forget that Kroger earned $2.0 billion last year on $115 billion in sales. This compares to Amazon's $2.3 billion of profit on $135 billion of sales. In other words, Kroger sells almost as much as Amazon does, and Kroger focuses on selling food, while Amazon focuses on selling everything. The idea that Amazon will now crush Kroger in the grocery space is completely unrealistic, yet you can buy twenty-six Kroger's for the price of one Amazon.
I think the reaction from the market on the news that Amazon.com is acquiring Whole Foods is completely out of line with reality. It appears to me that Amazon stock is in a complete bubble, with investors delusional about the future. The fact that Amazon is acquiring a struggling brick and mortar grocery retailer is not something that should be viewed as a threat to the existing champions of brick and mortar retail. Rather, it should be interpreted as a confirmation that brick and mortar is an essential part of being a successful omnichannel retailer. While I understand that markets can be irrational for many years, it's hard to ignore things like Wal-Mart's $31 billion of operating cash flow and e-commerce growth rate being higher than Amazon's. Investors can't forever ignore Target's ability to fulfill e-commerce orders directly out of stores and deliver them in a matter of hours. They also can't ignore the fact that Kroger has been crushing Whole Foods for years, and that Kroger's grocery sales are nearly as high as Amazon's total sales. I believe we are reaching "Peak Amazon" and investors should expect a reversal in the share prices of these companies going forward.
Disclosure: I am/we are long KR, WMT, TGT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.