AmazonFresh: Good Or Bad Move For The Stock?

By Will Ashworth | June 05, 2013 AAA

AmazonFresh, Amazon's (Nasdaq:AMZN) online grocery business, is moving out of the testing phase and into Los Angeles and then San Francisco later this year. Many have tried and failed at online groceries but none with as much financial firepower. Is its move into online groceries a good or bad move for its stock? I'll have a look.

SEE: 10 Reasons Why Online Grocery Shopping Is Failing

Online Grocery Biz
When investors think of online grocery delivery they usually conjure up images of Webvan, the e-commerce darling of the late 1900s. Webvan got its start in 1999 in San Francisco and a year later paid $1.2 billion in stock for HomeGrocer, one of its biggest competitors. In hindsight Jim Barksdale (founder of Netscape) and the rest of the HomeGrocer investors would have been better served taking a smaller cash offer. Webvan ceased operations in July 2001.

There were others of course. Peapod was started by two brothers in Evanston, Illinois, in 1989. It went public in 1997; Dutch retail conglomerate Ahold (OTC:AHONY) then acquired 100% of the company for $110 million in three stages between April 2000 and July 2001. Today Peapod is in 24 markets including Chicago, New York, Washington D.C., Philadelphia and others. Recently, it's been adding click-and-collect service in many of its markets so customers can order online and pick up at their local Stop & Shop and Giant grocery store. Since its humble beginnings Peapod has made more than 24 million deliveries. I'd say Peapod is here to stay.

In Canada, Grocery Gateway got its start in 1999 and struggled mightily until Longos, a Toronto-based family-owned grocery chain, acquired it in 2004. Co-founder Stephen Tallevi continues to run the online grocery service for the Longo family. Since being acquired in 2004; it's grown every year since. My elderly parents use the service and there's never been a glitch. My wife and I shop at the local Longos grocery store primarily because of the freshness of its products. The combination is a winner in the greater Toronto area. With 5 million people stretched for time, the service makes a lot of sense. I'm not as confident if Longos was to attempt to take the service beyond its local area. But certainly the evidence in Canada is that we have no problem ordering groceries online.

SEE: Is Online Shopping Killing Brick-And-Mortar

Does It Have To Make Money?
It's a strange question I know but not as crazy as you might think … here's why. Amazon isn't just selling groceries like Peapod or Grocery Gateway. It sells everything under the sun. Using my parents as an example--what if they were to buy one non-grocery item a week for the next year through Amazon? Now multiply that by a million people and Amazon's economies of scale tips in its favor. Groceries become the jug milk of its business model--the loss leader if you will--getting more customers through the proverbial door.

Furthermore, if you've followed its business over the years you'll know that CEO Jeff Bezos isn't concerned about margins. In a Businessweek article from January 2013, Bezos stated: "Percentage margins are not one of the things we are seeking to optimize … It's the absolute dollar free cash flow per-share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that's something investors can spend." What he's really saying is that Amazon's prepared to forego profits, unlike Kroger (NYSE:KR) or Safeway (NYSE:SWY), for as long as it feels it can gain market share. Grocery Gateway's Tallevi believes that Amazon has the money to experiment with different business models and will likely be very happy just to break-even given it's gaining a direct link into a consumer's home.

Good Move/Bad Move
While the internet is littered with casualties from the online grocery war, there are many examples in the U.S., Canada, and the U.K. where it is working just fine. Amazon became a logistics company rather than a retailer a long time ago. Its focus is figuring out how to get things to people as efficiently as possible. Businesses like UPS (NYSE:UPS) should be just as worried about Amazon's grocery business as the food retailers are. That's because if it gets to 20 urban markets by the end of 2014, it's going to want its own trucks. Whether it buys, builds, or outsources to a third-party is a question that's yet to be answered. What's clear, however, is that Amazon's in this to win.

SEE: Free Cash Flow Yield: The Best Fundamental Indicator

Bottom Line
Jeff Bezos is one of the most successful entrepreneurs of our time. If he feels now is the time to step off the curb and take a chance with online groceries, who am I to doubt him. The upside of this move is far greater than the downside. If you can buy-and-hold and wait for this to play out, you'll win whether it's successful in groceries or not. But I like his chances.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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