Is Amazon-Whole-Foods Merger The Knockout Blow To Retail?

Amazon (AMZN) has been just about the worst thing to happen to the traditional retail sector in decades, if not longer. Stalwarts such as Sears (SHLD) and JCPenney (JCP) sit on the brink of extinction. More current names like Macy’s (M), Kohl’s (KSS) and Target (TGT) are getting hammered as business continues to shift away from traditional brick-and-mortar to towards the online channel.

On area that Amazon hadn’t ventured too far into yet was the grocery space. Sure, it has the AmazonFresh grocery delivery service in several larger markets and the recently debuted checkout-less Amazon Go store in Seattle, but the company’s presence in groceries has been relatively muted. That changed in a big way today when Amazon announced its intent to purchase Whole Foods (WFM) in an all-cash deal that could ultimately be driving another nail into the retail sector’s coffin.

The grocery industry is a notoriously thin margin business, so it begs the question why it wants to enter an area of the market that may end up paying little in the way of dividends. I think there are a couple of reasons for this. First, if there’s one thing that we’ve learned over Amazon’s 20-year history as a publicly traded company is that it’s never been terribly interested in the bottom line. Jeff Bezos has always been plowing all available resources into growing the company into a global behemoth. What started as an online bookstore now sells everything from furniture to electronics to apparel and operates the world’s largest cloud infrastructure business, Amazon Web Services. Amazon is not interested in generating profits. It’s interested in being involved in every aspect of your daily life.

And that, I believe, is the real reason why Amazon targeted Whole Foods. Groceries is perhaps the one area of the market the company really doesn’t have a foothold in yet. Since they want to be all things to all people, it makes sense to try to own this area of the market too. And since the company essentially wants to dominate every area it operates in, it’s not surprising they decided to acquire a big player in the space in order to get things moving quickly.

The online grocery delivery business has largely failed up to this point. Peapod, probably the most famous online grocery delivery service, has been around longer than Amazon and still only operates in 11 states plus the District of Columbia. Can Amazon grow adoption of online grocery delivery? It certainly has the scale and the infrastructure to make it happen and the Amazon name alone may be the biggest competitive advantage it has to growing this segment of the market.

Looking at the broader retail picture again, there seems to be little reason for optimism within the rest of the sector. While clothing and home goods retailers were struggling, Kroger was a bright spot. From the beginning of 2012 through the end of 2015, the stock was up roughly 250%. After Friday’s move, it’s now down about 50% from that high point. The grocery business has never been a growth industry, but at least it was relatively steady. Like many other niches within the retail space, that stability now appears gone with Amazon’s big move into the space.

The SPDR S&P Retail ETF (XRT) is the obvious play on the sector. It’s down about 10% on the year and has a portfolio of around 100 names spread across many areas within the industry. The VanEck Vectors Retail ETF (RTH) is up around 6% year-to-date thanks to its 17% position in Amazon. Walmart, Costco, Kroger and Target, all stocks that have been hit hard on Friday, comprise another 20% of the fund. The Amplify Online Retail ETF (IBUY) is an interesting way to play the transition to online. It’s up around 27% this year.

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