Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

Is Amazon Really a Threat to Grocers?

Some of the most interesting and most bombastic headlines of 2016 were devoted to Amazon Go; the next generation grocery store the Everything Store is testing in Seattle. Typical was Time’s claim that Amazon Plans to Totally Reinvent Grocery Shopping.

To be accurate much of Amazon Go is little more than a souped-up variation on a variety of innovations that other retailers; such as Kroger (NYSE: KR) and Walmart (NYSE: WMT), have been playing around with for years. These include self-checkout, app payment and pickup of online orders.

Kroger’s Click List is available at hundreds of stores; and Walmart has several pickup locations open in the United States. Amazon Go is not even open to the public yet; while Walmart recently opened two convenience stores designed specifically for pickup and a drive up in Minneapolis.

Despite that the testing in Seattle raises an intriguing question: is Amazon (NASDAQ: AMZN) really a threat to grocers? Can the Everything Store decimate supermarkets in the same way it has pulverized brick and mortar book stores, clothing emporiums, department stores and sporting goods retailers?

Are Low Supermarket Margins an Opening for Amazon?

If one looks at the financial numbers of some supermarket operators the answer might be yes.

Supervalu (NYSE: SVU); the operator of such brands as Cub Foods and the bottom-feeding Save a Lot discount outlets, reported a profit margin of .8% on August 31, 2016. Supervalu also reported a net income of $163 million and a free cash flow of $106 million despite revenues of $17.12 billion for second quarter 2016.

The nation’s biggest standalone grocer; Kroger reported a profit margin of 1.47% and a free cash flow of -$555 million, despite $113.89 billion in revenues for third quarter 2016. Despite those revenues Kroger reported holding just $374 million in cash and short-term investments on October 31, 2016; even though it reported generating $4.444 billion in cash from operations on the same day.

Supervalu reported having just $57 million in cash and short-term investments on the same day. In contrast the organic grocer Sprouts Farmers Market (NASDAQ: SFM) had $50.29 million in the bank on September 30, 2016, from $3.991 billion in revenue.

Another organic grocer, Whole Foods Market (NASDAQ: WFM); often regarded as one of the nation’s top supermarket operators, reported $730 million in cash and short-term investments from $15.72 billion in revenues on the same day. Whole Foods reported a free cash flow of $255 million and a net income of $507 million on the same day.

An Industry in Turmoil

As you can see margins are low in the grocery business and cash is in short supply. The sector is also being heavily disrupted by the growth of national retailers like Walmart, Kroger and the privately-held Safeway. If Amazon was not enough to worry about traditional grocers are also threatened by new players such as the German deep-discounter Aldi, dollar stores and Costco Wholesale (NASDAQ: COST).

Other worrisome trends include food deflation and the collapse of oil prices both of which are cutting into profits. Kroger in particular has been stung heavily by low fuel prices; because it operates 1,387 supermarket fuel centers and 784 convenience stores. The effects of food deflation and low fuel prices are made worse by growing income inequality and wage stagnation which give consumers less disposable income to spend on food.

The grocery business can best be described as an industry in turmoil. The last few years have witnessed the bankruptcy and disappearance of one major regional grocer; A&P, the near collapse of another regional grocer; Roundy’s which ended up selling itself to Kroger, and the near collapse of the organic grocer The Fresh Market which also ended up selling out to avoid collapse.

We also witnessed the near collapse of a major national grocer; Albertsons, which has been folded into Safeway. Dozens of Albertsons stores have closed and others are being converted to Safeway locations.

A Shrinking Market

If all that was not bad not enough there was alarming statistic that made headlines over the Summer 2016. For the first time Americans spent more on dining out ($54.857 billion) than groceries ($52.503 billion), Quartz reported. To add to grocer’s woes the average American household spent 43.1% of its food expenditure on dining out in 2012 up from 25.9% in 1970.

This means that grocers are competing aggressively for a shrinking market at a time when they have to worry about a relentless new competitor like Amazon. The shrinking spending on groceries also raises questions about Amazon’s growing foray into the business. Is it wise for Bezos to spend money in a market that is getting smaller?

Safeway store at 6700 NE 162nd Ave. photographed Wednesday March 12, 2014 in Vancouver, Washington. (Troy Wayrynen/The Columbian)

The increased spending on prepared meals also creates an opportunity for supermarkets and a major problem for Amazon. Some grocers including Kroger and Whole Foods are already investing heavily in precooked foods. Whole Foods stores contain cafes and buffets full of food.

Many new Kroger stores contain sit down and take out eateries including pizzerias, taco bars and Asian cafes. Safeway has also been aggressively expanding its deli and hot food offerings including soups.

So strangely enough the growing popularity of dining out might be supermarkets’ best defense against Amazon; and low-priced competitors such as dollar stores and Aldi. After all it is hard to imagine a drone delivery of a container of hot soup.

There are of course serious limitations to hot food for grocers; including higher labor costs, and intense competition from fast food and quick-serve restaurants. Opportunities including online ordering and delivery also abound in the hot-food segment.

Grocers will Survive Amazon

My take is that the major grocers; and high-end grocers like Whole Foods, will survive but many of the regional and discount chains will not. Instead of being a direct threat to grocers, Amazon will be an indirect threat taking some business and providing another headache for grocers.

Expect to see Amazon carve out a profitable high end niche in the grocery businesses but most of the major brands to survive. Those supermarkets that invest heavily in hot food and higher end products like organics will do best. Many others especially regional chains will be driven into the hands of Kroger or Safeway.

Therefore Amazon is an indirect threat to grocers, one of many and hardly the largest. For the foreseeable future, supermarket investors should worry more about Kroger and dollar stores as direct threats to traditional grocers than Amazon.