Setting the Stage for Grocery Industry Competition in 2018

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In this 2017 year in review, the Motley Fool Industry Focus cast revisits Amazon's (NASDAQ: AMZN) acquisition of Whole Foods, and the encroachment of European discount grocers Aldi and Lidl, to understand how the battle for grocery market share is shaping up in 2018.

A full transcript follows the video.

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This video was recorded on Dec. 19, 2017.

Vincent Shen: Moving on to June, a busy month for us with two multi-billion dollar announcements in the grocery industry. The first being Amazon's $14 billion acquisition of Whole Foods Market. Asit, this deal made a ton of headlines and has been covered pretty extensively so far. Any big takeaways or things to watch for investors going forward?

Asit Sharma: I think there are two, Vince. One, and this has, like you said, been covered extensively in many publications, including The Motley Fool, the impact on this in the grocery industry is going to be huge. But I believe, actually, it's going to be positive on the grocery industry in general and also for the new combined company. That's because this merger is forcing companies to figure out the new model of grocery delivery, which is online ordering, and often times delivery or drive-in pick up from the parking lot. Amazon is going to accelerate all of this and it will sharpen the instincts of companies like Wal-Mart (NYSE: WMT), like Target (NYSE: TGT), which we saw just buy Shipt.

The other thing which is prudent to investors that's not as well covered is the impact of Whole Foods on Amazon itself. Amazon, as everyone knows, has focused on revenue in favor of profits. For all its sales over the last couple of years, it's had $3 billion of operating income in 2015 and just over $4 billion in 2016. Now, Whole Foods has had operating income of $850 million for the last couple of years. We don't have exact numbers, though they released their annual report, and there were a lot of acquisition expenses in there that cut into that operating income. But you're talking about one-fifth of the profit that Amazon makes in a year, they got in this $14 billion acquisition. So there's something really positive on Amazon's income statement. Those of you who have enjoyed investing in Whole Foods and now maybe are owning Amazon, because you followed them there, it's actually a very sharp boost to the company's ability to take margin out of other places in its business, which I find, frankly, attractive.

Shen: Thanks, Asit! Our second bout of headlines from June and also in the grocery industry came from companies based overseas. Aldi announced that it would look to spend over $3 billion to open an additional 900 stores in the U.S. market. Management at Aldi wants to have about 2,500 stores in this market by 2022, which would make it the third largest supermarket chain. In that same month, its rival in Europe, Lidl, opened its first U.S. locations starting on the East Coast. Early targets are for 100 stores by 2018. That sounds like a lot more competition for Kroger (NYSE: KR), Wal-Mart, Costco (NASDAQ: COST), and also the dollar store chains, given that Aldi and Lidl are known for their low prices and focus on discount. What do you think?

Sharma: This has been surprising somewhat to me, Vince, because this was the year in which Lidl landed on the shores here in the U.S. Aldi is also going to spend another $1.6 billion just for remodeling, on top of the numbers that you gave. Many of us who follow the grocery industry thought there would be an immediate impact, like a doomsday scenario. But the expansion has been concentrated, so far, right where I and you are, in the mid-Atlantic states on the East Coast. That's given the big chains a chance to study how the prices are changing in local markets and how they're going to react. The impact has been muted so far.

In fact, in the trade publications I follow, it said that Lidl might actually slow its expansion just a bit, because they're finding that sales have not panned out to their projections. What we have in this very dense corridor is an expansion of chains like Wegmans, which many listeners in the Northeast know, expanding south, and Publix, for our listeners who are down in Florida and the East Coast, they know that chain very well. They're all converging on this central point in the mid-Atlantic. And that gives the incumbents like Whole Foods and Wal-Mart and Costco, Kroger, Target, it gives them all time to study this like a laboratory and figure out how they're going to react.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Asit Sharma has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.