Whole Foods released its annual report last week. It will likely be the last glimpse we get at Whole Foods' financials now that Amazon (AMZN 4.44%) has bought the grocery chain.
Amazon disclosed its physical stores' revenue last quarter but didn't provide any more details. The Whole Foods report provides additional information on how investors can expect Amazon to affect Whole Foods' operations going forward. Even after owning the business for about one month in the third quarter, Amazon is already having quite an impact on Whole Foods' business.
Image source: Whole Foods.
Returning to sales growth
Whole Foods grew sales 4.4% in its fiscal fourth quarter to $3.65 billion. That's a stark improvement over the sub-2% growth Whole Foods had seen since the beginning of 2016.
Amazon's physical stores generated $1.28 billion in the third quarter, largely coming from one month of operating Whole Foods. While Amazon operates several physical bookstores, those store generated just a few million in revenue last quarter.
Even though Amazon's numbers suggest a slight increase in revenue during the month it owned Whole Foods compared to the other two months of the grocer's fourth quarter, it doesn't account for the entire spike in revenue. More likely the news buzz surrounding the acquisition drove more shoppers to Whole Foods throughout the quarter (Amazon and Whole Foods announced the acquisition June 16).
Margin pressure
While the buzz around the acquisition might have accounted for the growth in sales last quarter, it can't account for the pressure on Whole Foods' margins. Amazon started slashing prices immediately after closing the acquisition, but it couldn't touch prices before that.
Nonetheless, Whole Foods' gross margin in its fourth quarter fell to 33%, down from 34.1% in the fourth quarter last year and 34% in the previous quarter. Operating margin (excluding acquisition expenses) fell to 2.5% from 4.4% last year and 4.9% last quarter.
That 2.5% operating margin looks nice compared to Amazon's 0.8% margin last quarter, but it might also be a bit inflated. Remember, Amazon only operated Whole Foods for one month, so the margin pressure is very likely even more severe than it appears on Whole Foods' financial report.
Driving no-profit traffic
True to form, Amazon's playbook of sacrificing margin in exchange for better traffic and higher revenue appears to be working with Whole Foods. Despite a revenue increase last quarter, Whole Foods' profits declined. It wouldn't be a surprise if that trend strengthened in the fourth quarter given a full three months of Amazon calling the shots.
It's important to think about how Whole Foods fits into Amazon's business. Even if Whole Foods stores themselves don't produce very much profit, they can support Amazon's services.
Amazon is already extending Prime benefits to Whole Foods, and it plans to make Prime the loyalty program for the stores. That can drive Prime subscriptions.
Whole Foods also provides 460 U.S. locations for customers to pickup or return items ordered from Amazon.com, providing faster fulfillment and easier returns for more shoppers.
And as Amazon moves further into groceries, Whole Foods provides a supply chain and instant scale in the industry. That can give Amazon the scale it needs to compete on pricing with online grocery sales.
Whole Foods' fourth-quarter results are exactly what Amazon investors should want to see. It's all about driving traffic to the stores to allow Amazon's other businesses to benefit. Direct profits from grocery sales should be a bit of an afterthought at this point.
