Whole Foods Market Well-Positioned for Gains as Organic Food Sales Soar

U.S. organic food production has more than doubled since the late 1990s; however, the consumer appetite has grown even faster, with organic food sales increasing from $3.6 billion in 1997 to $21.1 billion in 2008, and now accounting for 3 percent of total U.S. food sales. Despite this doubling, organic food production only represents 0.5 percent of all U.S. crop land and pasture, leaving plenty of room for growth in this burgeoning food product niche business. We believe that U.S. organic food sales will surpass $100 million by 2020.

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Source: Nutrition Business Journal

Today more than two-thirds of U.S. consumers buy organic products at least occasionally, and 28 percent buy organic products weekly, according to the Organic Trade Association. Organic food products are now firmly established in the American food culture, and what was once available only in natural product stores, are now found in mainstream venues like Wal-Mart (WMT), Target (TGT), and Costco (CSCO).

The top selling categories are fruit, vegetables and dairy products, accounting for more than half of organic food sales in 2007. These categories are followed by soymilk and other beverages, packaged foods, breads/grains, snack foods, condiments, and meat.

A recent survey by the Hartman Group suggests that about 50 percent of those who frequently buy organic food have incomes below $50,000, and that African-Americans, Hispanic and Asian-Americans use more organic products than the general population, as shown by the organization’s Core Organic Consumer Index.

These statistically significant findings have huge implications for marketers who traditionally have only targeted the upper-class white cohort of organic food consumers. While it is true, given their large numbers in the overall population, that the typical organic consumer is white, the real opportunity for the out-of-the-box corporate thinkers in terms of revenue growth lies with the other ethnic groups, who have a core organic preference, especially the fastest growing group, Hispanics.

Why do Hispanics have a closer tie to organics? In general terms, they have resisted taking up the “ready meal solution” en-mass because of their close and more recent connections to the land and the authenticity of its products, the findings by The Hartman Group’s survey showed.

“Compared to White Americans, Hispanics are significantly more likely to buy organics for the following reasons: to support the environment, to avoid pesticides and genetically modified foods, to support better treatment of farm animals, "for my children" and because organic food tastes better.”

One of the major constraints for organic food growth has been the lack of reliable supplies. However, it appears that help is at hand with the state of Illinois grasping the bull by the horns. A recent article in Grist.com (a Beacon in the Smog) showed how Illinois is tackling this problem and providing a model on how simple it is to increase the supply of organic or fresh food. The state’s new organic food legislation will build the infrastructure for what will be a ground-breaking regional fresh food system in Illinois, that could be a model for the country.

Grist.com writes:

“This Illinois state legislation establishes a council to develop a fresh farm and food system in the state, and it creates a system that allows buyers for state agencies to pay up to 10 percent above the lowest bid when purchasing locally grown foods. It also sets a goal for state-owned agencies to increase their purchase of locally grown foods each year so that 20 percent of their food purchase is spent on Illinois-grown foods by 2020.

“Currently, an estimated four percent of the money Illinois residents spend on food each year is for products grown in the state, and just several hundred of the state’s 76,000 farmers are producing for the local market, according to a task force report.

“That last statistic is astonishing. Illinois has tens of thousands of farmers and only one half of one percent of them sell their products in their home state. The new law is all the more impressive when you realize that Illinois is second only to Iowa in corn production—we’re talking the heart of the Corn Belt here. It’s quite a statement when a top agricultural commodity state has decided it’s time to diversify its food production. And make no mistake, institutional buyers are exactly what growers need to have the confidence to give up their reliance on commodity crops, which they can always sell to the local grain elevator. Asking a farmer to grow something that he or she can’t hope to sell isn’t exactly a recipe for success. But what happens if they know the state will not only buy their produce, but pay a premium for it? I’m smelling a win-win here.”

The number of Illinois farmers producing organics for farmers markets has tripled in the last ten years, but is still not enough to meet the demand from the commercial market. This new legislation should help encourage local farmers to meet this lucrative growing demand. This simple, effective and almost uncontroversial legalization is strategically brilliant. We believe if all 50 states adopted similar policies it would go a long way in helping to solve U.S. long-term health and rising obesity problems.

We believe that the 2008-2009 recession was an important milestone for the industry as it proved that organic products are economically viable, as they did not take a “sales nose dive” as predicted by many consumer experts. In fact, it did the reverse and the market has continued to thrive. Even the White House has joined the bandwagon with the recent launch of “White House Farmer’s market,” that will run through the Fall.

What does this growth demonstrate? We believe it is further proof that the trend towards organic food is not a fad, but a true testament to the way in which consumers want their food grown, processed and handled. Despite economic difficulties during the last two years, consumers are willing to pay more for organic produce.

The era of “cheap food” as represented by the 99 cents box of Ho-Hos is declining, as the ignored consequences of rising obesity, increased related health care costs, and environmental abuse continue to come to light. True, organic food has a more upfront cost (we would say investment); however, it would seem that consumers are voting with their wallets for a solution that leaves a far better taste in their mouth today and lesser health care costs further down the road. Surprisingly, in relationship to their size, white Americans need more encouragement to become better core organic consumers. This is no easy task given their acquired taste for unhealthy ready-to-eat meals.

So, how Can Investors Invest in this Organic Revolution?

Well, if you don’t want to become a farmer or open a stall at the local farmers market, Whole Foods Market Inc. (WFMI) is our favored vehicle to play this growing theme. Founded in 1978 in Austin, Texas, they are the leading natural and organic supermarket chain in the U.S., and the first nationally certified organic grocer.

As of September 2008, the company operated 284 stores organized into 11 geographic operating regions, 264 stores in 38 states; six stores in Canada, and five stores in the U.K.

Between 1992 and 2006 Whole Foods Market was an investors’ wonder stock that rose over the period from $2 to nearly $78. This placed the group on a price to sales ratio at nearly two times sales, with investor short-term expectations that were becoming impossible to meet. Higher commodity prices and a slowing economy resulted in the share price dropping 91 percent over the next three years, approaching almost $8 in November 2008. This placed it on a P/S of just over 0.1 times and offered a wonderful opportunity for investors willing to back the recovery of this organic food play.

Since then the stock has not disappointed in terms of share price, as the stock is up about 300 percent from the late 2008 lows and meeting recovery earnings expectations. In August, Whole Foods Market reported better-than-expected third quarter 2009 results. Earnings per share came in at 25 cents versus 24 cents a year ago. This surpassed the consensus estimates of about 19 cents, and was driven by stringent cost-control measures and improved store performance. On account of the better-than-expected results, management raised its full-year earnings outlook. Consensus estimates were raised to 85 cents for September 2009 and $1.10 for September 2010. This places the stock on a forecasted P/E for 2010 of 27.3 and price to sales ratio of 0.5.

The easy money has been made, but we feel the shares are not expensive given the company’s continued recovery prospects and expansion plans. The company will announce fourth quarter earnings and update expectations for 2010 on November 2. We would use any short-term weakness before or on this announcement as a buying opportunity.

Source: Ned Davis Research

Disclosure: No positions, but WFMI is featured in our model portfolio.

Comments

[TCK]

Always quite amused by the "Organic" marketing gimmick as here is not even a legal definition of the term organic. I always ask myself , how can a vegetable NOT be organic ?

Likely these are the same consumers who believe global warming can be combated by not turning on the heater in their car or starting a compost pile !

Having said all this I hope enough people will try the organic salmon at $25.00 per pound to make your investments profitable. Also , don't forget to pick up some organic tartar sauce ( on sale , $7.50 for 8 oz jar ) to top it off !

2009 Oct 15 09:01 AM

[Hexagit23]

TCK, actually, there is a legal definition of Organic, if you had bothered to spend one second to google search it, you would find out that the USDA regulates Organic food. All Organic foods have to be certified, you can't just label something as Organic and sell it. You ask how can a vegetable NOT be organic? I'm not going to bother wasting anymore time, you can google search it, and there's even a wikipedia entry on it. We live in the age of the internet TCK, and there's no excuse for your kind of ignorance. I mean, come on now, if you are smart enough to post a comment on here, you could at least spend one minute researching before you post and make yourself look like a fool. If anything, your post is great for a chuckle.

2009 Oct 15 10:21 AM

[TCK]

Good luck with organic fish !

2009 Oct 16 07:30 AM

[TCK]

The "regulations" are so broad as to basically be meaningless.

One minute of research turned up the following;

"Manipulation of regulations
Critics of formal certification also fear an erosion of organic standards. Provided with a legal framework within which to operate, lobbyists can push for amendments and exceptions favorable to large-scale production, resulting in "legally organic" products produced in ways similar to current conventional food"

and

"Manipulation of certification regulations as a way to mislead or outright dupe the public is a very real concern."


and

"In December 2005, the 2006 agricultural appropriations bill was passed with a rider allowing 38 synthetic ingredients to be used in organic foods. Among the ingredients are food colorings, starches, sausage and hot-dog casings, hops, fish oil, chipotle chili pepper, and gelatin. This allowed Anheuser-Busch in 2007 to have its Wild Hop Lager certified organic "even though [it] uses hops grown with chemical fertilizers and sprayed with pesticides"

Thanks to government "regulations", even pesticides can be labeled organic !

2009 Oct 16 07:46 AM

[User 267512]

Your right TCK. The "Organic" label is a bunch of BS but there has to be a starting point for this movement. Setting a limit at 38 synthetic ingredients is better than giving free reign to Big Agriclutrue. The organic proponents can try and whiddle it down from there. Besides there is obviously a demand for this type of product.

Personally, I love the idea of my food being more organic and and having it's food source being more organic. At this point however, there are few cases where I'm willing to pay the premium for it.

2009 Nov 07 01:11 PM