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Multi-billion-dollar Amazon deal a shot across the bow

Glenn Freeman  |  21 Jun 2017Text size  Decrease  Increase  |  

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Amazon's proposed $18bn Whole Foods acquisition in the US further supports Morningstar's view on an impending Australian retail shake-up.

 

Players in the highly-competitive grocery segment all face challenges ahead as Amazon prepares to roll-out in Australia. Both independent companies and the sector leaders alike will need to adapt.

While Woolworths (ASX: WOW), Wesfarmer's (ASX: WES) Coles and Aldi can leverage their scale to take an increasing share of supermarket expenditure, independent retailers--with Metcash (ASX: MTS) the sole wholesaler to the independent grocery channel--don't have the same size advantage.

While the more localised, neighbourhood footprint of the independent grocers has, in the past, enabled them to successfully differentiate their offering on convenience, "consumers are increasingly willing to sacrifice convenience for value," says Morningstar equity analyst, Johannes Faul.

Amazon recently announced its intended $US13.7 billion ($18 billion) acquisition of Whole Foods Market in the US. The deal would substantially expand the company's physical "bricks-and-mortar" presence and boost the scale of its fresh food business.

It also "signals clear strategic intent from Amazon in grocery, and perhaps illustrates their tacit recognition of the value of a physical store network," says Faul. He believes it will provide an opportunity for Amazon to accelerate its online grocery ambitions, and potentially pursue a hybrid online/brick-and-mortar grocery business model.

For Metcash, if Amazon follows a similar pattern when it officially launches in Australia, it would add considerable pressure to an already challenging environment--though only over the longer-term.

"With a market share in US groceries of just 1 per cent, despite operating in the segment since 2008, we expect repercussions of Amazon’s Whole Foods acquisition to take some time to be felt in Australia," Faul says.

Morningstar doesn't regard Metcash as holding an economic moat of competitive advantage, as it lacks the scale advantage of its larger competitors Woolworths and Wesfarmers--both of which hold narrow moats.

However, as Faul explains, all three are on negative moat watch: "Discounters such as Aldi, and e-commerce competition through players such as Amazon serve to disrupt the industry, weakening returns and hindering margin expansion for the incumbents as they compete."

"These competitive pressures underpin our negative moat trends for Woolworths, Wesfarmers, and Metcash."

From a more bullish perspective, he points to the traction Metcash is gaining through its strategic and cost-cutting initiatives undertaken by Metcash. Additionally, independent supermarket operators across all states are stepping up investments in new stores, additional floor spare and refurbishments.

On the downside, "a marketing war between Coles, Woolworths, and Aldi is leading to price deflation to capture sales volume. Softer economic forecasts for Australia also present a potential challenge, with tougher conditions for the consumer likely to substantially erode independent grocery retailers' core differentiation of convenience and service.

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Glenn Freeman is a Morningstar senior editor.

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