Image Source: Dominic Smith
Amazon continues to impress as its operating leverage makes itself evident, and its integration of Whole Foods with its Prime Membership seems to improve with each subsequent update.
By Kris Rosemann
E-commerce giant Amazon’s (AMZN) second-quarter report, released July 26, showcased its impressive growth trajectory as reported revenue leapt 39% on a year-over-year basis, and GAAP operating income came in at nearly $3 billion, almost five times that of the year-ago period, as its GAAP operating margin expanded to ~5.6% from ~1.7%. This helped propel diluted earnings per share in the quarter to $5.07 from $0.40 in the comparable period of 2017, and free cash flow generation exploded to $4.2 billion in the quarter, nearly six times that of the year-ago period. The company’s balance sheet remains strong as it held a net cash position of $2.4 billion as of the end of the second quarter.
Amazon’s 2017 purchase of Whole Foods deservedly garnered a high level of attention across the investment community, and the integration of the grocery store chain into Amazon’s core e-commerce business continues to keep other grocers on edge. In the second quarter of 2018, the company added more savings for Prime members at Whole Foods, including unique deals during its famous Prime Day. Prime member response to the discounts have been met by what management calls one of the fastest adoption rates its seen for a Prime benefit. In addition, Amazon has PrimeNow and AmazonFresh, its home delivery options for groceries, launching in markets all around the world, and management expects to continue rolling out new innovative ways to add convenience for shoppers. We currently value shares of Amazon at $1,938 each.
As Amazon sets the innovation pace in the grocery space, more traditional rivals are working to keep up. Kroger (KR) recently launched a new e-commerce platform called Kroger Ship, which is said to offer competitive pricing and free doorstep delivery for orders over $35, in a handful of markets with plans to expand the service in coming months. In addition to rumors tying it to a potential partnership with Alibaba (BABA), the company has made a number of investments in its e-commerce capabilities, including a partnership with e-commerce specialist Ocado Group, which brings with it fulfillment and distribution capabilities of notable scale. However, materially increased investments in new technology coupled with the price competition that comes with Amazon’s discounting efforts at Whole Foods are almost certain to continue impacting margin performance of the traditionally low-margin grocery space. We currently value shares of Kroger at $27 each, and its Dividend Cushion ratio leaves a lot to be desired (negative 1.1 at last check).
Walmart (WMT) is another prime example of Amazon’s impact on traditional retail and grocers more specifically. The retail giant is investing heavily in e-commerce capabilities to keep pace with Amazon, including partnerships with the likes of JD.com (JD) in China and a 77% stake in Flipkart, an innovative e-commerce company in India. The increased spending on e-commerce appears to be bearing fruit at this juncture as digital sales have grown rapidly in recent quarters (e-commerce sales at Walmart US leapt 44% in fiscal 2018). The company hasn’t been spared from aforementioned factors impacting margin performance, which has been impacted by pressures such as higher transportation costs, price investments, and mix effects from its growing e-commerce business. These issues are likely to persist in the near-term, and Amazon’s discounting presence in food retail will only add to the concerns. We currently value shares of Walmart at $88 each, and its Dividend Cushion ratio sits at a healthy 1.9 at last check, though such a ratio assumes relatively muted dividend growth moving forward.
US retail giant Target (TGT) opted to challenge Amazon head on during its Prime Day sale, and Target claimed to achieve its biggest online shopping day of the year thanks to high levels of promotional activity. Nearly 90% of the orders were fulfilled by Target stores, which is part of its strategy to make its online and physical stores the most efficient option for consumers. The company has done well in driving traffic more recently, but margin pressures in its business are evident as it continues to invest in digital initiatives, including same-day delivery expected to be available to 65% of US households by the end of 2018, amid the intense price war taking place. We currently value shares of target at $78 each, and its adjusted Dividend Cushion ratio sits at 1.7.
Amazon’s presence in food retail may have forced the launch of a new era of convenience for consumers, but it has certainly created headaches for traditional grocery store operators and their already slim margins. Large competitors with the capability to invest heavily in developing worthy competitors in the online retail space and weather the ongoing price war have the potential to come out of what may prove to be near-term pain stronger than in the past, but the dynamics of the industry have undoubtedly been changed. Additional consolidation may be likely, as evidenced by the sizable premium SuperValu (SVU) shareholders are in-line to receive from its takeover agreement with United Natural Foods (UNFI), the price tag of which came in at $32.50 per share in cash.
Food Retailers: CASY, COST, CVS, GNC, KR, SVU, SYY, TGT, UNFI, VSI, WBA, WMT
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.