Amazon.com, Inc ( AMZN) made a grand entrance into the grocery business earlier this month when it announced a $13.7 billion buyout bid for Whole Foods Market, Inc. ( WFM). But even though Amazon has massive disruptive potential in the grocery industry, Wells Fargo analyst Zachary Fadem says there is still plenty of room for long-term gains among a handful of select grocery stocks.
According to Fadem, investors must accept that Amazon will change the dynamic of the entire industry, particularly when it comes to pricing.
[See: The 10 Most Valuable Auto Companies in the World.]
While large-scale competitors such as Wal-Mart Stores Inc ( WMT), Costco Wholesale Corp. ( COST) and Kroger Co. ( KR) are best positioned to compete with Amazon on prices, they could all be forced to endure margin contraction in the event of a pricing war.
It may seem as if smaller grocers would be at a huge disadvantage in this scenario, but Fadem believes share prices of smaller grocery companies could get a boost as more of the larger competitors consider scaling their business via buyouts.
Fadem says Walmart outbidding Amazon for Whole Foods is “possible but unlikely.” However, he says Wells Fargo’s top grocery stock pick, Sprouts Farmers Market ( SFM), is a prime buyout target.
“With increasing potential for long-term grocery industry consolidation, we view SFM as a likely candidate … which in our view raises SFM’s valuation floor, despite a heightened competitive environment,” Fadem says in a research note.
[See: 11 Health Care Stocks for a Regular Dose of Income.]
But while investing on buyout speculation alone can be a risky endeavor, Fadem says Sprouts’ fundamentals make it the most attractive play in the grocery space regardless of a buyout bid.
“Even absent a takeout, we believe SFM remains well-positioned with differentiated and expanding product offerings, focus on fresh/value (attractive sub-segments) and growth opportunities from private label, prepared foods and digital initiatives,” Fadem says.
In addition to Sprouts, Wells Fargo is bullish on food distribution stocks Sysco Corp. ( SYY) and US Foods Holding Corp. ( USFD). Despite the new competition from Amazon, Fadem also says Kroger is attractive as a long-term value play given it currently trades at a 11.3 forward price-earnings ratio, well below its historical valuation.
Fadem is cautious on the outlook for both Walmart and Costco and says the stocks are near fair value given the potential for margin pressures and increased competition from Amazon and others.
[See: 10 Skills the Best Investors Have.]
Even with Amazon in the mix, Wells Fargo maintains “outperform” ratings on the stocks of Kroger, Sysco, US Foods, Sprouts and Whole Foods.
More from U.S. News
High-Tech Investing: 7 Sectors to Watch
The 9 Best ETFs for Retail Power
10 Best ETFs for Large-Cap Stock Growth
Grocery Stocks Could Get a Boost from Consolidation originally appeared on usnews.com
