Whole Foods Remains The Best Grocer...Hands Down

| About: Whole Foods (WFM)

Organic grocery store chain Whole Foods (NASDAQ:WFM) reported wonderful third quarter results, again outperforming its peers. Revenue surged 12% year-over-year to $3.1 billion, in-line with consensus estimates. Earnings per share rose 20% year-over-year to $0.38, also in-line with consensus expectations. Free cash flow totaled $115 million, equal to 4% of sales.

How Did Whole Foods' Peers Do?

The grocery business certainly is not a bull market. Competitor SuperValu (NYSE:SVU) reported weak results for its fiscal year 2014 first quarter. Revenue from continuing operations declined 1.5% year-over-year to $5.2 billion, as retail food same-store sales declined 3% year-over-year while Save-A-Lot same-store sales declined 1.5% year-over-year. Continuing operations also posted a loss of $0.34, much worse than the loss during the same period a year ago, while free cash flow was negative $207 million.

Safeway (NYSE:SWY) reported slightly better results for its fiscal year 2013 second quarter than rival SuperValu. Revenue declined 1.6% year-over-year to $8.7 billion, primarily because of fuel sales. In fact, when fuel sales are excluded, same-store sales increased 1.2% year-over-year. Earnings per share from continuing operations jumped 20% year-over-year to $0.24. Free cash flow year-to-date has been relatively weak at negative $418 million.

Why Can Whole Foods Do SO Much Better?

Image Source: WFM 3Q FY2013 Earnings Release

The reason behind Whole Foods' success is simple: tremendous store productivity growth. The above chart shows how same-store sales increased at different Whole Foods stores depending on the age of the location. As we can see, stores less than 2 years old had robust 17.2% comp growth, while stores that are over 15 years old still increased sales 5.8% year-over-year.

Whole Foods certainly has the wind at its back relative to the other grocers. The brand caters to a higher-income crowd that is less price-sensitive and also less adversely impacted by economic slowness. Additionally, organic food and even vegan diets have grown in popularity, particularly among the urban consumer that Whole Foods serves. For many of these customers, the price of food is secondary to the health benefits.

On top of growing sales at a strong clip, Whole Foods' gross margins expanded 60 basis points compared to the year prior to 36.6%. Co-CEO Walter Robb has warned repeatedly about gross margin pressure, but such has yet to come to fruition. Robb echoed this sentiment on the conference call, saying:

"I feel like I have become the boy crying wolf. We really are making price investments. So far, we were never been able to offset on the buy side plus really get better shrink control than we have had but as we are working through our plan going forward, we will begin to see some of these price investments maybe nipping gross margins a little bit but hopefully helping our COGS up through the strategic decisions that we think will produce, in the long-term, greater profits for our shareholders."

While Robb remains cautious, we think the true gross margin profile of Whole Foods may be around 35-36%, slightly higher than the long-term goal of 34-35%. Competition in many markets is virtually non-existent, and we doubt many upstarts will want to go head-to-head with Whole Foods.

Though comp sales are "only" up 5.8% thus far during the firm's fourth quarter, management boosted its full-year sales outlook to 11% total sales growth on same-store sales expansion of 7.2%-7.3%, modestly higher than its previous forecast. Earnings-per-share-guidance for the full-year was also raised a few cents to $1.45-$1.46, which is also in-line with consensus expectations.

Valuentum's Take

Whole Foods' execution is second to none in the grocery space, and the firm has several powerful tailwinds to help bolster top and bottom line growth. All things considered, we like the company, but shares trade at the high end of our fair value range (at the time of this writing), so we would need to see a material pullback before considering adding the firm to the portfolio of our Best Ideas Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.