The purpose of this article is to discuss Whole Food Market, Inc. (WFM) and its attractiveness as an investment option. To do so I will review the company's past performance, most recent annual and quarterly reports, and examine current trends in the industry to attempt to determine where the stock may be headed from here.
To start, a little about WFM. WFM is an international retailer specializing in natural and organic food supermarkets. It operates in the United States, Canada, and the United Kingdom, with a large percentage of its stores in the U.S. Currently, WFM operates around 350, of which less than 20 are in either Canada or the U.K. The company competes with other retailers and grocery chains such as Wal-Mart (WMT), Kroger (KR), and The Fresh Market (TFM). The company's stock is currently trading at $103.77/share and pays a quarterly dividend of $.20/share, which translates to an annual yield of .77%. Year to date the stock is up almost 14%, excluding dividend payouts, and over the past 52 weeks the stock is up almost 25%.
I reviewed WFM's most recent quarterly report from May 7th, for its 12-week second quarter that ended on April 14, 2013. The report offers some mixed trends for the company. While sales growth was in double digits at 13.3% and same store sales growth was at 6.6%, both these figures have trended downwards for two consecutive quarters. While neither of these trends are positive, my main concern is the slowing of same store sales growth, down over 22% in a year over year comparison and down 7% from the previous quarter. While total sales are growing, WFM has been expanding so additional stores can provide growing sales even if same store sales are slowing. This could be due to a variety of factors, such as new WFM stores cannibalizing previously existing stores or customers could be shopping elsewhere.
On the flip side, when looking at sales and cost of goods sold, a different picture is painted. Total sales for WFM increased 13.5% over a full year period. Cost of goods sold increased at a slightly lower pace, at 13.3%. This means that WFM has been able to increase sales while maintaining its margin, which is currently at a higher rate than competitors such as Wal-Mart and Target (TGT), which are around 24% and 29%, respectively. This quarter, WFM reported a gross margin of 36%, higher than its three year range of 34-35.5%, and much higher than its competitors. That means that WFM earns more than its competitors on each dollar of sales. This makes sense since WFM competes on differentiation, offering organic, unique, and locally sourced products as opposed to competing on price. Therefore, its products are priced higher and earn a higher margin. With net income increasing year over year by 22%, WFM has managed to turn its higher priced products into higher income.
There are some risks for WFM. One, it is heavily reliant on the U.S. market. If consumer spending declines or unemployment rises here at home, WFM has little opportunity to soften this blow by making its sales up elsewhere. While WFM has international exposure in Canada and the U.K., it does not have a presence in any emerging markets, which is where a lot of the growth is occurring worldwide, and will occur in the near-term, for major U.S. companies. Also, many consumers have become conditioned to shopping based on price and have flocked to stores such as Wal-Mart and Dollar General (DG) during the recession to save money. While WFM managed to maintain its margins and grow sales during a very difficult economic climate and in a highly competitive industry, it appears able to withstand the storm. However, if we dip back in to a recession and consumers trade down on grocery items, WFM will be disproportionately effected.
Another risk has to do with same store sales growth. With under 400 stores nationwide, WFM certainly has room to expand. This would normally provide a good boost for a stock. However, as WFM has added new stores, same-store sales have suffered. This is going to limit the company's ability, and willingness, to expand if it cannot maintain sales in existing stores prior to opening new ones. While WFM could look to grow internationally, the U.K. is a territory mired in economic problems and with a consumer base even more frugal than the U.S. Heavy expansion in that region seems unlikely, and not prudent, in the near term. While Canada represents a more attractive market for expansion, and the company states in its 2012 annual report that "significant opportunities exist in Canada", it has yet to make a significant investment in that country to back up its talk.
Bottom line: WFM is a company that is servicing a growing need among many consumers to obtain organic, natural, and locally sourced products. It sells premium priced groceries that allow the company to earn a gross margin higher than the competition. Investors have recently been rewarded handsomely as the stock has rebounded tenfold since the depths of the recession. However, growth appears to be slowing for the company. Same store sales are slowing as the company expands, and the company is heavily reliant on areas where consumer spending is still constrained and focused on value. While the company has doubled its dividend since 2011, the yield is at such a low level (under 1%) that it gives investors little incentive to purchase the stock for any dividend income. Since the stock is trading at almost 40 times earnings, pays an inconsequential dividend, and operates in an increasingly competitive industry, I would caution investors away from this investment at this time.