Amazon's AMZN $13.7 billion ($42 a share) purchase of Whole Foods Market WFM came as something of a surprise. But when you think about it, the deal makes perfect sense for both.
Whole Foods, the upscale grocery retailer known for its extensive local sourcing and fresh, organic produce, has survived by charging a premium for its specialty, profits from which were distributed to investors. But business hasn't been that great of late with customers getting thrifty in the wake of a prolonged economic downturn. It has also been troubled by activist investor Jana Partners, which used its recently-acquired 8% stake in the company to push for greater cost control and a sale of the company.
A decentralized model such as the one Whole Foods uses for most of its wares, calls for a higher capital outlay, but it's the only way to get high-quality produce to customers. So the company may be able to drive efficiencies from the technology that Amazon brings to the table. Amazon also has the capacity to operate at practically no profit for the longest time, pushing out competitors and capturing market share. This policy can help it expand into new areas under the Whole Foods brand (there aren't any details about what Amazon intends to do with the high-quality high-price brand, but it will likely continue it).
For Amazon, thre is the obvious lure of Whole Foods' 450 odd stores across the U.S., which extends its physical reach. A physical presence is essential for grocery delivery because of its perishable nature and the supply chain is no doubt attractive to Amazon, which has not really gained much momentum with its grocery efforts to date, possibly because of less depth in local sourcing.
Amazon may also be able to use the physical presence to showcase its other products (it continues to increase its stable of in-house brands in addition to the growing number of digital devices like Kindle, Fire, Echo and Dash).
What's more, the omni-channel practice of order online and pick up at store may now become a viable option for grocery. Customers typically like to see and touch fresh produce before buying, so they often don't buy things like fruit, vegetables and meat online. But the option to pick up at the store may get more customers to open up to online purchasing. Once comfortable with the idea, they might just tell Alexa to arrange it.
Needless to say, this isn't particularly good news for other grocery chains like Wal-Mart WMT and Kroger KR , both of which saw their shares plummeting after the announcement. While both these companies and Wal-Mart in particular have been investing in technology, they aren't quite where Amazon is today.
Amazon, with its technology platform, artificial intelligence investments, logistics prowess and delivery experience, has all the capabilities to make a splash in groceries and take share from existing players.
Amazon still generates the bulk of its revenue from retail although it has a growing cloud business and also makes money from devices and subscriptions. Despite the fact that it's been around for quite a few years, it is growing revenue at an accelerated rate (19.5% in 2014, 20.2% in 2015 and 27.1% in 2016). It continues to invest heavily in expansion, leading to losses in some years and profits in some.
Amazon shares are up 13.2% in the last three months compared to just 2.7% appreciation in the S&P 500. But the electronic commerce market of which it is a part, has jumped 17.4%, beating Amazon in the period.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report Amazon.com, Inc. (AMZN): Free Stock Analysis Report Wal-Mart Stores, Inc. (WMT): Free Stock Analysis Report Kroger Company (The) (KR): Free Stock Analysis Report Whole Foods Market, Inc. (WFM): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research