Sunday, June 18, 2017

Amazon, Whole Foods and Shopping Center REITs

Amazon’s proposed takeover of Whole Foods sent shock waves through the grocery, packaged food and shopping center REIT industries. The instant judgement of the market was that the deal is very good for Amazon and bad for the three industries named. Seemingly oblivious to the true import of the deal were stock analysts who cover the REIT industry. To them the deal ratifies the value of what they characterize as high quality real estate. To be sure the 460 or so Whole Foods’ locations mostly sit on some of best shopping center real estate in the country, but that is a tiny segment of the industry.

Nevertheless that really misses the larger point. Amazon’s roll in life is to destroy the gross margins of its competitors. Thus if Amazon succeeds, and it doesn’t always, the 21% gross margin of supermarket operator Kroger will be a relic of the past. My guess is that under Amazon, Whole Foods’ industry high 35% gross margin will give way to something much lower. Although most analysts use sales/square foot as metric for rent paying ability, the true metric is gross margin/square foot and that is about to collapse for most food retailers. As a result rents will fall. Just think of all the grocery stores that will face pricing and market share pressures from the combined behemoth. Trust me, it is not going to be pretty and investors will soon find the safety they sought in grocery anchored centers to be illusory.

What Amazon appears to be doing is to link up the high income consumers who are Amazon Prime customers with the equivalent Whole Foods customer. In fact of all of the supermarket chains in America there is probably the greatest overlap between Whole Foods shoppers and Prime. Simply put Amazon wants to own the high income consumer which will make it easier for the Whole Foods customer to buy goods on Amazon Prime while shopping with the physical store becoming either a delivery point (where the customer takes physical delivery) or a distribution point (where the goods are shipped out to the customer). In essence Amazon will be placing its digitally sophisticated integrated global logistics capabilities at the service of the high income-time constrained consumer.

One last point, to the extent that Amazon will “own” the high income consumer it will be bad news for the operators of A+ regional malls.

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