Broad implications for retail
According to Euromonitor, the U.S. grocery market is $780 billion in size, with just over $9.8 billion (approximately 1.3%) of those sales placed online. While the overall grocery market is expected to grow at less than 2% annually through 2020, excluding inflation, online grocery is expected to grow at a rate of 8.5%. To the extent that Amazon has decided to pursue a bricks and mortar solution for the first time after years of testing Amazon Fresh and other approaches, we believe it confirms that the online-only model for food is a difficult path. However, an increased focus on food retail at Amazon is likely to portend more disruption across the food retail sector. Our view at Signature is that the deal makes sense, particularly given Whole Foods’ urban, upper-income footprint and as 62% of Whole Foods shoppers are also Amazon Prime members. With the potential to convert more Whole Foods shoppers to Prime membership and offer them grocery delivery across the U.S. within 1-2 hours, we believe the deal will allow Amazon to take a further share of its customers' wallets.
The Whole Food acquisition presents a large opportunity for Amazon to leverage many of its technologies (i.e., Amazon Fresh, Amazon Go/automation, Alexa, etc.) to grow and optimize the Whole Foods business. Amazon is expected to use its new store footprint to sell much more than just groceries, and the addition more than 465 Whole Foods stores across 42 U.S. states will enable it to promote its private label business among various categories and provide a new consumer distribution point for Amazon devices such as the Echo. Conversely, Amazon has a history of competitive pricing when entering new categories, so we would expect Whole Foods’ current profits to be reinvested into pricing (the grocer’s prices are between 20-30% more expensive than conventional food retailers) to drive faster adoption and share gains. We expect Amazon to utilize the stores to carve out space for same-day item pick-up. Finally, the organic food category is likely to become available to more households and income levels. We see the acquisition and its implications as a material event for direct competitors, with incremental long-term risk to market share, profitability, and earnings per share. Finally, we believe that the acquisition could be a further step for Amazon into the $465 billion U.S. health care industry; as non-medicinal grocery items account for approximately 30% of retail chain pharmacy revenue and food accounts for 10%-15% of those front end sales, or 3%-4.5% of total revenue.
Implications for consumer packaged goods (CPG) companies
Over the past decade, large established brands have suffered market share erosion to premium, niche, and health and wellness brands. Pricing power for U.S. CPG has been called into question with the introduction of hard discounters (mainly using 100% private label) in the U.S. and the price investment made by Walmart ($2 billion over the past two years). With this acquisition there is real risk that manufacturers will be pressured to make price concessions either in the form of lower list prices or more trade spending subsidies. Any price concessions would likely weigh on sales growth as well as margins, given low elasticity in the industry.
Whole Foods has a small network of 13 stores in Canada; with an estimated share of the Canadian grocery sector of less than 0.5%. We believe the near-term risk is modest. Amazon already has a modest online grocery offering of mainly packaged and dry goods through Amazon.ca, but no fresh offering like Amazon Fresh at the moment. We believe that the limited number of stores in Canada would not give Amazon a materially scalable retail or distribution opportunity, as Whole Foods supplies its Canadian stores through distribution centers in northern U.S. states and through third parties. In the near term, we believe that Canadian supermarket chains (Loblaws, Metro, and Sobeys) will need a significant investment in capital expenditures before online grocery rollout, as it is unclear how close Amazon was to launching Amazon Fresh in Canada.
We believe this transaction is a game changer for food retailers, much as it would be if Tesla bought one of the auto manufacturers or Alphabet (Google) bought Microsoft. But we don't believe that food retail will disappear because of this transaction. As demonstrated in the electronics segment, companies such as Best Buy in the U.S. and Dixons in the U.K. have proven that it is possible to compete against Amazon by improving their footprint, cost structure, online platform and product offering and by adding additional services.
This transaction means two things to us. Firstly, more price competitiveness and additional investment in the online offerings by food retailers in North America, which will lead to margin pressure and lower cash flow generation going forward. The street believes that 20-30% of the sector’s profit pool is at risk. Secondly, the weakest players are expected to go out of business, similar to what the electronics segment experienced between 2000 and 2010. We expect to see consolidation of food retailers as scale and market share remain key in this industry.
We are current shareholders of Amazon in the Signature equity funds and balanced strategies.
This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. This commentary may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.