Amazon-style discounts on food items sold through Whole Foods Market will lead to big market share gains in the grocery category, says Morgan Stanley.
The firm reiterated its overweight rating for Amazon shares, saying the internet giant will also acquire more subscribers to its Amazon Prime shopping club as a result of its Whole Foods acquisition, which was finalized on Monday.
Amazon vowed last week to slash prices at the organic grocery chain beginning Monday "on a selection of best-selling grocery staples," including selections of fruit, vegetables, dairy and meat.
"One of Amazon's sharpest competitive edges is its ability to consistently operate at razor thin margins. We expect more of the same with Whole Foods," analyst Brian Nowak wrote in a note to clients Sunday. "We see lower pricing leading to accelerating WFM [Whole Foods Market] share gains."
Nowak reaffirmed his $1,150 price target for Amazon shares, which is 21.7 percent higher than Friday's closing price.
The analyst said Whole Foods' average food item price is approximately 14 percent higher than the average grocery store. He cited a recent survey in which 70 percent of consumers who don't shop at Whole Foods blamed pricing as the primary reason. Then again, the survey said 60 percent of Whole Foods customers, or about 5 million people, aren't Prime members, leaving plenty of room for the retailer to pick up customers by cutting prices.
"Over time, Amazon Prime will become the Whole Foods customer rewards program, with special savings and in-store benefits," he wrote.
He estimates Amazon can expand its Prime membership base by 8 percent annually over the next three years, resulting in 14 million additional subscribers.
"This may prove conservative if AMZN is successful in cross-promoting Prime into WFM…which given the average Prime sub spends 4.6X more than non-Prime members on Amazon.com, makes us bullish about the AMZN's long-term profit potential," the analyst wrote.
Amazon shares have outperformed the market this year. Its stock is up 26.1 percent year to date through Friday versus the S&P 500's 9.1 percent gain.