Will Amazon's Whole Foods adventure derail Tesco plc's turnaround?
Amazon seems to be trying to disrupt every retail market it can access. For established companies, this is a huge problem as Amazon has proven itself to be highly efficient at conquering market share, wherever it sets its sights.
So when the company announced that it was buying upmarket supermarket Whole Foods earlier this year, food retailers around the world shuddered.
The Amazon-Whole Foods deal officially completes tomorrow, and Amazon is wasting no time stamping its mark on its prey.
Indeed, at the end of last week, Amazon announced that it will cut prices on organic staples such as bananas, avocados, eggs, farmed salmon, kale and lettuce, some apples, butter and other products. As Whole Foods has a limited presence here in the UK, initially the impact of these changes will be minimal. There are fewer than 10 UK Whole Foods stores, most of which are in London, but considering Amazon's rapid pace of expansion, it won't be long before more are opened.
It will be yet another thorn in the side of UK supermarkets. Amazon already has a well-established UK distribution network, and it won't take much for the company to develop its offering and sell Whole Foods products online around the country.
The presence of yet another competitor may derail the Tesco(LSE: TSCO) turnaround plan.
Since its accounting scandal in 2014, Tesco has been working hard to improve margins and tempt customers back into its stores. The plan seems to be working. In the first three months of this year, like-for-like sales rose by 2.3% - ahead of analysts' prediction of 2.2%.
Still, the firm's recovery looks fragile. Even though sales are ticking higher, profit margins are razor thin. For the financial year ending 28 February 2018, analysts are expecting the company to report a pre-tax profit of £1bn on sales of £57bn.
If Amazon sets off another price war, Tesco will have to slash prices further and increase loyalty rewards to maintain sales growth hitting the bottom line -- bad news for investors but good news for customers.
Not much room for manoeuvre
Shares in Tesco currently trade at a forward P/E of 18.4, a high multiple that does not leave much room for manoeuvre. If there is a price war with Amazon, the company's recovery would have to be put on ice, and it's difficult to tell how the retailer's shares would react to lower growth expectations.
Considering the problems Tesco is still facing, and the likelihood of a price war with Amazon, it may be time for investors to dump the retailer. The shares look expensive, and an estimated dividend yield of 1.7% does not look particularly attractive. There are plenty of other companies out there with brighter outlooks for growth and market-beating dividend yields.
Time to sell?
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes