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Whole Food Market (WFMI) is the largest chain of natural and organic food stores. The company is increasing its private label presence and maintains a good corporate image through promotion of health, care about communities and the environment.

Business

Whole Foods Market was founded in 1980 in Austin, Texas and operates the largest chain of natural and organic foods supermarkets in the United States (183 locations with an average size 32,000 sq. feet). Whole Foods Market's goal is to offer the highest quality, least processed, most flavorful and naturally preserved foods, while devoting to the promotion of organically grown foods, food safety and sustainability of our eco-system. The company also has four subsidiaries, Allegro Coffee Company, Pigeon Cove, seafood processing facility, Select Fish, West Coast seafood processing facility, and Produce Field Inspection Office as well as two non-profit organizations, which were created in 2005, the Animal Compassion Foundation and Whole Planet Foundation.

The company plans on growing mostly through new store openings with stores in the range of 50,000-60,000 sq feet.

Financial Overview

FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05
Revenue $892.1 $1,117.3 $1,389.8 $1,567.9 $1,838.6 $2,272.2 $2,690.5 $3,148.6 $3,865 $4,701.3
NI -$17.2 $26.6 $45.4 $42.2 $28.9 $51.6 $84.5 $103.7 $137.1 $136.4
EPS -$0.14 $0.27 $0.41 $0.39 $0.27 $0.46 $0.70 $0.83 $1.05 $0.99
Debt $84.3 $92.7 $158.7 $208.9 $298.1 $250.7 $162 $162.9 $164.8 $12.9
Shares Outstanding 76.7 97.8 106 105.5 105.9 109.5 115.5 120.1 124.8 135.9
Avg. PE na 26.10 31.90 25.30 41.80 30.10 28.90 30.90 36.20 55.20
ROE na 12.9 16.4 13.6 na 16.6 14.3 13.4 13.9 10
*Revenue, Net Income, Debt and Shares Outstanding are in millions

Private Label Products

Within the natural foods products there is a lack of national brands, which Whole Foods Market has identified and is determined to fill in this gap. Currently Whole Foods Market has four private brands, which include 365 Everyday Value, Whole Kids Organic, 365 Organic and the Whole Brands family, as well as a number of store-made and regionally-made fresh items sold under the Whole Foods Market label. Total private label sales accounted for approximately 7% of retail sales in fiscal year 2005. The following have been taken out of the 2005 annual report:

• 365 Everyday Value. In 1997, we introduced a line of products under the “365” label emphasizing everyday value. These products meet our quality standards but are generally less expensive than the alternative products we sell. Our qualitative and quantitative research indicates that the “365” line is a highly recognized and trusted brand with Whole Foods Market shoppers.

• Whole Kids Organic. In 1998, we introduced the country’s first organic food product line developed just for children under the “Whole Kids” label. Whole Kids Organic offers great tasting items, from applesauce and peanut butter to pasta sauce and string cheese, crafted expressly for a child’s discerning palate.

365 Organic Everyday Value. In 2002, we expanded our private label program with the introduction of our “365 Organic” line. The “365 Organic” brand provides all of the benefits of organic food at reduced prices. Certified organic products are purchased in large quantities so that the savings may be passed on to our customers. In 2003, we expanded this program into non-grocery departments, including a successful line of organic fresh vegetables.

• Authentic Food Artisan. In 2003, we introduced our Authentic Food Artisan (“AFA”) program. This program recognizes distinctive products that are made using traditional methods. Potential items for the AFA program are reviewed on a quarterly basis, specifically chosen for their superior taste and commitment to artisanal, small-scale production methods. The line includes olive oils, cheese, wine, pasta, vinegar, rice and honey, among other items.

• Whole Brands. In September 2004, we introduced a new family of “Whole Brands,” each aligned with department-specific quality and sourcing standards. Included under the “Whole Brands” umbrella are “Whole Kitchen” for frozen grocery, “Whole Treat” for frozen desserts and candies, “Whole Catch” for frozen seafood items, “Whole Fields” for produce and produce support items, “Whole Pantry” for pantry items such as flavored olive oils and vinegars, “Whole Creamery” for cheeses, “Whole Dairy” for eggs, and “Whole Ranch” for frozen burgers and franks. These brands go beyond the basics, offering unique items that embody our high quality standards and supplement our base value line of 365 and 365 Organic items. Items in the “Whole” family share a consistent logo format and packaging so that our customers know each is part of a greater family.

I believe that it is key for Whole Foods Market to continue to expand their private labels in their stores. It will definitely help increase gross margins and customer loyalty.

Corporate Image

Whole Foods Market probably has one of the best corporate images in the United States, by helping to promote issues like health, animal welfare, and community.

Whole Foods Market created two non-profit organizations, the Animal Compassion Foundation and Whole Planet Foundation where they raise money through two global “Five Percent Days,” in which five percent of all customer purchases at all Company stores are donated.

The mission of the Animal Compassion Foundation is to provide education and research services to assist and inspire ranchers and meat producers from around the world to adopt more humane practices and achieve a higher standard of animal welfare excellence while still maintaining economic viability.

The primary focus of the Whole Planet Foundation is to improve the economic well-being of the poor in developing countries by assisting entrepreneurship and self-employment through income-generating micro-businesses via access to capital from micro-loans.

With the two organizations, the company has raised over $1.1 million dollars.

Whole Foods Market made a landmark purchase of renewable energy credits from wind farms to offset 100% of the electricity used in all of its stores back in January of this year. This is the largest wind energy credit purchase in the history of the United States and Canada and makes Whole Foods Market the only Fortune 500 Company purchasing wind energy credits to offset 100% of its electricity use!

The company has strong values and will continue to pursue programs like this in the future. Reading up on these remind me of a company with similar values, The Body Shop, a Canadian company.

Various Facts

John P. Mackey, co-founder of the Company, has served as Chairman of the Board and
Chief Executive Officer since 1980. He also served as President from June 2001 to October 2004

Company was added to the S&P 500 in December

Had a 2-for-1 stock split on December 27th

On November 9, 2005, the Company's Board of Directors approved a 20% increase in the Company's quarterly dividend to $0.30 per share and a special dividend of $4.00 per share, both payable on January 23, 2006 to shareholders of record on January 13, 2006.

On November 9, 2005, the Company's Board of Directors approved a stock repurchase program of up to $200 million over the next four years. Thus far the Whole Foods Market has not repurchased any stock, which I think is positive. I don't believe that purchasing the stock price at anywhere close to these levels would be a good use to the company’s cash.

United Natural Foods is the largest supplier, accounting for approximately 22% of our total purchases in fiscal year 2005.

The required cash investment for new stores varies depending on the size of the store, geographic location, degree of work performed by the landlord and complexity of site development issues. For stores opened during the past two fiscal years, new store investment has averaged approximately $11.6 million excluding pre-opening expenses, which have averaged approximately $1.5 million per store.

Conclusion

Whole Foods Market is a best of breed company in the natural and organic foods category. I believe there is still plenty of room for this company to grow within the United States alone. However, the company is selling at too high of a multiple for me to buy in, and I would like to wait for the price of come down quite a bit more before I looked into buying even though the company is selling for 17% below its 52 week high. I would also like to see less dilution of the outstanding shares. Since 1996, shares have been diluted over 77%, and even since 2003 shares have been diluted by over 12%. This is one company I’m sure to track and watch it progress throughout the years until I find a comfortable valuation to purchase it at.

WFMI Q1 conference call, Feb 8, 2006 Notes

Q1 Sales increased 22 percent driven by 15 percent weighted average year-over-year square footage growth and 13 percent comparable store sales growth.
Produced double-digit comps for nine quarters in a row.
New stores not included in the comp base continue to produce very strong sales averaging $623,000 per week compared to $585,000 for all stores.
Sales per gross square feet increased to a record level of just over $900.
Due to seasonality, gross margin is typically lower in the first quarter than for the remainder of the year, averaging 34.2 percent over the past five years. “We believe our historical annual results, which have consistently been in the range of 34 to 35 percent of sales, continue to be the best indicator of our future results”.

Aim to be competitively priced on the same or similar items in grocery and Whole Body, while perishables, which are just under 70 percent of sales, may be priced at a premium to reflect the higher quality of product available in our stores.

Including $1.1 million in share-based compensation expense, net income increased 26 percent to $58.3 million on top of a 26 percent increase last year, and diluted earnings per share increased 17 percent to $0.40 on top of a 21 percent increase last year. The above average five percent increase in fully diluted shares outstanding year-over-year was due to the significant 61 percent increase in average stock price over that time, along with a considerable increase in stock option exercises following the accelerated vesting of all options in late September.

Produced operating cash flow of $0.61 per share, and Economic Value Added improved $8.7 million to $16.3 million.

Ended the quarter with 180 stores and approximately six million square feet in operation. Five stores were opened during the quarter.

Over the last five fiscal years, average store size has increased 22 percent, while average weekly sales per store have increased 65 percent.

Produced $89 million in cash from operations allowing us to self fund $69 million in capital expenditures of which $35 million was for new stores.

During the quarter, roughly 2.9 million stock options were exercised, and proceeds from the issuance equaled approx. $130 million. 7,000 Zero Coupon Convertible Debentures were converted to 145,000 shares of common stock resulting in a $3.6 million decrease in convertible debentures to $9.3 million at the end of the first quarter.

WFMI in the future

Plan to open two additional stores in the second quarter, a 46,000 square foot store in Woburn, Massachusetts and a 50,000 square foot store in Henderson, Nevada; as well as fully re-open a store in Metairie, Louisiana which was also closed due to Hurricane Katrina.

Except sales to grow 18 to 21 percent in fiscal 2006, with same stores sales to increase 8 to 11 percent and weighted average square footage growth of 14 percent.

Expect diluted earnings per share growth to be slightly less than guidance range for sales growth of 18 to 21 percent. This is due to an estimated increase of approximately 5 to 6 percent in diluted shares outstanding resulting from an expected year-over-year increase in stock price and stock option exercises. Expect share-based compensation in the second quarter to be in line with the first quarter on an average weekly basis and then increase to approximately $2 to $3 million in the third and fourth quarters, as annual grant date at which the majority of options are granted is early in the third quarter.

Goal is to reach sales of $12 billion by 2010, but believe there is room to grow sales greater than $12 million.

From the Q&A portion of the cc:

Challenges in executing stores: parking lot, back rooms tight, second, third shifts, and more deliveries, hence reason for expanding stores.

Think same store average can go above $900/sq foot, even 50% above that.

Moving to more average American, goal was to open better stores, and make them bigger to get all the programs Whole Food Markets wanted in there, every department has gotten bigger. Seeing a broader customer base.

Driving comp store base, overall gains coming from bigger stores, bigger sales, and the larger stores have more of a selection to offer. When open Large stores, relocate smaller stores that are around there.

Consumer wants more fresh and prepared food, and bigger stores allow this, which helps to create a more rich experience. When over 60% of shopping is impulse, the wide variety of choice gives the customers to choose from fresh, or self prepared.

Full Disclosure: I do not own WFMI as of this writing

Source: Whole Food Markets: A Stock I'd Like To Own (WFMI)