Is This The Death Of Grocery?

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Includes: AMZN, COST, KR, WMT
by: Bottom Fisher Ideas

Summary

Negative headlines abound about the fate of brick-and-mortar grocers at the hands of Amazon.

It is important to put things into historical perspective.

Rather than an indictment of brick-and-mortar grocery, Amazon's purchase of Whole Foods is a validation.

Investment Thesis

There is intense negativity surrounding the grocers, and things may well get worse before they get better. It's important to put the negative headlines in historical perspective, however. Amazon (NASDAQ:AMZN) won't be the only winner in the grocery space; there will be other companies that emerge stronger than before.

Media Accounts

Is the grocery store dead? The headlines are dire indeed.

From a piece titled "Supermarket Smackdown" in a popular magazine:

"There really is a crisis in the industry," says Gary Giblen, head analyst at boutique Manhattan research firm CL King & Associates. The sky started falling — along with same-store sales...

"Conventional supermarkets really have no reason to exist anymore," says Giblen. "They're basically becoming convenience stores."

In an article titled "Investors Check Out From Grocery Stocks" in Barrons:

Whether a customer is shopping for pomegranate juice for a martini or a jug of laundry detergent, the traditional supermarket is not always his or her first stop anymore.

An affluent shopper can find lots of specialty items at Whole Foods (NASDAQ:WFM) or Trader Joe's, while bargain hunters need drive only a few miles to a big discounter such as Wal-Mart Stores (NYSE:WMT) or Costco (NASDAQ:COST).

But the intense competition makes shares of supermarket chains less appetizing.

"If Wal-Mart takes the low-end consumer and the local upscale chains take the high-end consumer, where does that leave the mainstream food retailer?" asks Bill Sipper, an independent food and beverage industry consultant based in Ramsey, NJ.

From the article "An Identity Crisis for Supermarkets" in the New York Times:

Georgiana Gardiner has no use for conventional supermarkets. When Ms. Gardiner, who lives in a Denver suburb, wants fresh fish, meats, produce, and other perishables, she drives 25 minutes to the nearest Whole Foods Market. When she needs products like canned beans, pasta and paper towels, she stops at a Wal-Mart Supercenter, which has a full grocery store.

It has been at least a year, she said, since she entered a Safeway or Kroger (NYSE:KR), the two national supermarket chains that operate in the Denver area.

Historical Perspective

You can be forgiven if you didn't realize that these news accounts were from 2004 and 2005, as they are strikingly similar to the headlines today.

At the time of these articles, the specter of "a growing threat from steamroller Wal-Mart Stores" (as described in a 2002 article in Barrons) had been hanging over the grocers for a few years, much as Amazon has been looming over retailers today. Wal-Mart was portrayed as a behemoth who was going to put the traditional grocery stores out of business by employing non-union workers, improving supply chains and logistics, and aggressively undercutting prices.

Sound familiar? It should.

Today the headlines are "It's a Nightmare for Grocery Stores But It Might Make Your Groceries Cheaper", and "Amazon and Whole Foods: Is This A Grocery Apocalypse?" Not so different from the headlines in the early 2000s at all. I couldn't help but use my own sensational headline, but only to make a point.

Things were bleak for the grocery industry for some time, and there WERE casualties. Some companies went out of business, others were acquired, and still others were taken private. But the narratives, that the only winner was going to be Wal-mart and that customers would abandon traditional grocers, were false ones. The weaker companies lost, but the stronger companies like Kroger and Costco survived and picked up market share from their fallen competitors. If you purchased shares in the best managed companies at those depressed prices, you were handsomely rewarded over the next 10 to 15 years.

There is no doubt that Amazon will shake up the grocery store space, but I would be skeptical of anyone who tells you that "this time is different."

The Amazon/Whole Foods Deal

The recent offer by Amazon for Whole Foods has inspired our imaginations. The thought of drones taking organic avocados and grass fed steaks to your doorstep for a fraction of the price that you pay at the supermarket is certainly exciting. But not very realistic.

My takeaways from the proposed acquisition are a bit different and less fanciful.

  1. Amazon's previous grocery strategy was not working. They had managed to capture less than a half of a percent of the grocery market and they felt they needed to make a big move in order to compete.
  2. There is execution risk with the strategy. Jeff Bezos has proven himself to be a master of execution, however, so chances are good that he will pull it off. Amazon's track record of increasing efficiency and shrinking margins in order to capture market share makes some sense when combined with one of the least efficient and highest margin grocery businesses, Whole Foods.
  3. History tells us that the market's reaction that Amazon will gain and everyone else will lose out is not correct. There will be losers, but there will also be winners besides Amazon, and the winners will end up with more market share in the long run. According to a recent report, the two biggest players in the US grocery business are Wal-mart with 14.5% of all grocery sales and Kroger with 7.2%. The combined Amazon-Whole Foods will come in at only 1.4%. That leaves plenty of room for market share expansion by multiple participants.
  4. The Amazon-Whole Foods deal is a vindication of brick-and-mortar grocery stores, not a repudiation of it. If a physical presence wasn't necessary in the grocery space, Amazon wouldn't have bought 450 stores in order to compete.

Conclusion

Despite the negative headlines, the narrative of Amazon winning and everyone else losing is unlikely to be correct. I don't know for sure which companies will survive the upheaval in the grocery industry, but the ones that do will be stronger because of it. I'd look for opportunities to pick up strong grocery retailers at distressed prices.

Disclosure: I am/we are long KR.

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.