Amazon: Pricing Trumps Execution Woes at Whole Foods

Revenues at Whole Foods during the fourth quarter were slightly higher than its new parent Amazon had anticipated, officials said, as demand associated with lower prices in stores helped to overcome negative effects of supply issues.

But until price cuts are more meaningful, and in-stock issues subside, it’s unlikely competing grocers are feeling much impact from the combination yet, Barclays analyst Karen Short said in a note to clients this week.

“Until execution issues are resolved and broader price cuts are implemented, we believe traction on sales will stall, so for now the pressure on the industry has abated,” Short said. “When (not if) broader changes are made (and it is only a matter of time, in our view), Whole Foods’ traction will pressure other grocers—not just large public players, but also smaller independents.”

Whole Foods’ modest sales momentum came in a quarter during which Amazon otherwise posted huge increases in sales and smashed its own expectations for operating profits.

Revenues have soared by 38% to $60.5 billion, with operating income of $2.1 billion growing by 69%, well in excess of the company’s guidance. CEO Jeff Bezos in a statement cited the success of its voice-controlled Alexa device, which caught on with consumers, developers and brands during the course of the fiscal year ending Dec. 31.

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“Our 2017 projections for Alexa were very optimistic, and we far exceeded them. We don’t see positive surprises of this magnitude very often—expect us to double down,” Bezos said. “We’ve reached an important point where other companies and developers are accelerating adoption of Alexa. There are now over 30,000 skills from outside developers, customers can control more than 4,000 smart home devices from 1,200 unique brands with Alexa, and we’re seeing strong response to our new far-field voice kit for manufacturers. Much more to come.”

Sales in physical stores—almost entirely from Whole Foods—totaled $4.5 billion in the period. The company posted $1.3 billion in physical store sales during its third quarter. This included only a few weeks of results from Whole Foods, which it acquired in August.

Officials in a conference call discussing results said they are continuing technical work integrating Amazon’s Prime loyalty into Whole Foods. Thus far, the partnership is resulting in expansion of Whole Foods’ brands on Amazon, the addition of Amazon lockers at Whole Foods' stores and in-store signage promoting the combination as "better together." In November, Amazon and Whole Foods combined on a turkey promotion for Prime members, but much more is to come, officials said this week.

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“So far, our focus has been on continuing to lower prices even beyond the initial ones that we discussed at the close of the deal in late August,” Brian Olsavsky, Amazon’s CFO, told analysts. “We've launched Whole Foods products on our Amazon website, and technical work continues to make Prime the Whole Foods customer rewards program. We expect to have more on that later in the year.”

Olsavsky said Whole Foods recorded a small operating loss in the quarter, but operating income was positive, excluding accounting issues associated with the fair market value of those assets taken at the time of its acquisition.

Out-of-stock issues recently reported at some stores were primarily associated with increased demand due to pricing action, along with weather-related issues, Olsavsky said. He said Amazon has made no changes to Whole Foods’ supply strategies, although the retailer was in the process of implementing category management at its stores prior to the acquisition. That appears to have resulted in supply disruption as it adjusts assortment.

“I'd say Whole Foods is not less in their commitment to providing the best selection of high-quality products and having them in stock for customers,” Olsavsky said. “We've made no changes post-acquisition that would have impacted anything related to in-stock, except perhaps the fact that the price decreases have brought up demand and there's an amount of rebalancing related to that. So I think the out-of-stock issue is … tied more to the increased demand that we're seeing, and also selective weather-related restocking issues.

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 “Where there’s issues, they’ll be corrected,” he added. “Where there's areas we can improve our selection and delivery for customers, we'll do so.”

In North America, sales were up 42% to $37.3 billion, and operating income was up 107% to $1.7 billion. Net earnings for the quarter were up 148% to nearly $1.9 billion.

For the fiscal year, Amazon’s total sales increased 31% to $177.9 billion. Operating income decreased 2% to $4.1 billion, while net income was $3 billion, or $6.15 per diluted share, a 25% increase.