Amazon & Whole Foods, Retailing #5.0

By Jeff Kelly on June 29, 2017

The morning of June 16, 2017, I was in Seattle. As the news of Amazon buying Whole Foods broke, there was dancing in the streets. Costco announced they would triple the number of free samples for the day, Microsoft gave away software with no viruses, and Starbucks promised free lattes for all those fortunate enough to be in the Emerald City. The clouds parted and the sun began to shine through for all to see! Okay, not really. But the deal has captured the interest of many investors. While this merger may usher in a new era of retailing, do not fear, it is not the end of every other retailer or their “invest-ability.” Quite the contrary, we think the deal could mark a turning point for some high-quality retail companies.

First, let’s look at some of the facts and potential repercussions related to the deal:

• Amazon grew its footprint significantly acquiring Whole Foods 460 locations as well as its distribution capacity.
• Amazon wanted and needed physical stores to be closer to the customer for same day delivery. It grew its US DC capacity by nearly 30% on 10% sales accretion. (Brian McGough at Hedgeye Risk Management)
• This deal should not be dilutive. (Hedgeye and Bank of America)
• Don’t be shocked if Amazon isn’t done. Dicks Sporting Goods, Best Buy, and even Bed, Bath and Beyond are not out of the question. Amazon can also acquire very cheap leases out of bankrupt Radio Shack and Payless stores. (Hedgeye Risk Management)
• Amazon could also just use Best Buy as a showroom as described in this article: https://consumerist.com/2017/06/28/best-buy-is-now-a-showroom-for-amazon-google-home-products/
• Target likely wanted Whole Foods. A counter bid by Target is not likely, but possible. It is possible Target will now make a bad acquisition, which leads to real problems, store closings etc. (Brian McGough at Hedgeye)
• Retail sales done online is still only approximately 12% of total sales. Brian McGough, Retail Analyst at Hedgeye Risk Management, thinks it can head north of 34% in the next ten years. If this occurs, he believes we will see upwards of 50% of brick and mortar stores close.

Amazon has its sights on the markets in which they do not yet have significant traction. For example, Amazon recently moved Prime into the lower end consumer market. This move was necessary to remain competitive, and because their penetration of the high-income consumers was out of runway. Prime currently has significant penetration in high end U.S. households. Continuing to increase this percentage will allow Amazon to offer all the services they envision.

The retail business is moving quickly. After years of stagnation, it’s innovate or die. Amazon and other retailers are looking to cutting edge ideas to enhance their online experience. They will use forms of augmented or virtual reality to allow people to see how clothing will look on them based upon actual simulations of the customers’ features. The consumer will also be able to see how a couch, stove, or bedroom set will look in their home, and can also change the colors or fabric patterns in the moment to find what is most appealing. This will not just look like their home, but it will be an actual simulation of their home, with the same dimensions and lighting. There is good reason why Lazy-boy just completed a deal to sell on Amazon.

It will take this type of creativity and reach to compete in the future of retail. Amazon and Walmart appear to be leading the competition in a broad sense. We believe that other high quality companies will also succeed. In the past, leaders such as Nike, Home Depot, and Costco have developed retail models which helped them stand out from the pack. They could do so again. Many companies will leave the scene via bankruptcy, while others will die a long painful death. In the end, companies need to have brick and mortar as well as robust online channels. This takes vision and money. Those choosing to save rather than spend could be doomed to failure. Meanwhile, in Seattle, avocado toast for everyone!

Have a great day.

Retailing #5.0 is a phrase coined by Brian McGough of Hedgeye Risk Management. Numbers quoted and some text are via his research and FactSet. Inputs also from Bank America.