Amazon & Whole Foods: The Deal of the Year

Whole Foods store locations

By now the world knows that Amazon and Whole Foods have agreed to a deal in which Amazon would acquire upscale grocery chain for $13.7 billion.

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The reaction to the deal has been extremely positive for Amazon, with the e-giant’s stock increasing over $15 billion since the deal was announced.

In essence, Amazon shareholders picked up Whole Foods for free. This exuberance was not shared by other grocers, such as Kroger, Target, Costco and Walmart.

We now have a “Death by Amazon” index whose holdings lost over $32 billion in market value on Friday alone, as seen in the chart below.

While investors are digesting the speculation, we believe it is  premature to put the nail in coffin of the Walmart and Kroger grocery business.

Although this deal is a big one, we don’t anticipate any major changes to Whole Foods in the near-to-medium term.

When he addressed Whole Foods employees, CEO John Mackey said that this acquisition will “make a big difference in the food industry.” He did assure employees that that product quality, company benefits and salaries will remain the same, which is always a concern following a change in ownership.

Whole Foods has always focused on its employees and stakeholders, as highlighted in John Mackey’s insightful book, “Conscious Capitalism.” This philosophy contrasts with Amazon’s employee culture in recent years.

Time will tell how these very different companies will mix together.

We are taking a wait-and-see approach.

Our sense is that this deal for CEO Jeff Bezos is an incubator for physical stores. Amazon has been in the “grocery” space since 1999 and only recently looked to establish physical locations.

It currently generates over $6 billion in online grocery sales; however, only $1 billion of that would be considered “food retail.” Also, Whole Foods has delivery options in place due to its relationship with Instacart; therefore, this impact on food delivery is uncertain.

There is considerable conjecture that Amazon wanted the physical locations for same-day, last-mile delivery for its other goods. We doubt this was the primary driver for the acquisition either. Amazon generates over $5 billion in “small basket” grocery, but interestingly, the top items are not food, as seen in the graph below.

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While growth in these categories is evident over the last few years, these bulk items are not in large inventory at a Whole Foods location, compared to Walmart, Costco or Kroger stores. Also, when looking at Whole Foods locations across the U.S., most are in middle-to-upper class areas, comprising only 440 locations.

Unknown 6Source: Bernstein Research

Knowing this, using stores as regional hubs for same-day delivery does not seem to be the driving motivation for this deal. Whole Foods’ stores are focused on an experience of fresh food and ready-to-eat food on-the-go, not warehousing thousands of pounds of laundry detergent.

We are not discounting Amazon revolutionizing the grocery industry; however, we believe  this transaction should be viewed as an initial step into physical retail and that there will be an evolution over the next several years.

This may include leveraging Amazon Prime membership for online orders when there is limited same-day delivery or store pick up. Only time will tell, but we believe this isn’t the end of the road for Costco and Walmart; rather, it will make this category more interesting to follow.

Amazon in Oregon

While it will be interesting to see if Portland-based New Seasons sees any disruption of business, Amazon has thus far been a positive force in Oregon.

In May, Amazon announced that they will build their ninth data center in the state, this time in Troutdale. Prior to this announcement, no other center was in the Portland area due to the value that Amazon can find for land and power in other areas in the state.

With last month’s announcement, there are high hopes of more than 1,000 new jobs. Whether or not this growth will offset potential Whole Foods layoffs at any of their 10 stores in the state remains to be seen.

We remain optimistic that Amazon growth will continue to be a positive for the Pacific Northwest.

Jason Norris, CFA, is executive vice president of research at Ferguson Wellman Capital Management.

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