Will Whole Foods' Market Outperform?

| About: Whole Foods (WFM)

According to a report issued by Stores Magazine and Deloitte Touche Tohmatsu, a surprising number of ranking changes among supermarket and grocery stores occurred in 2013. These changes are very significant since Whole Foods Market, Inc. (NASDAQ:WFM) moved up nine ranking positions on the list of the world's largest food retailers in 2012. This trend continued as Whole Foods Market Inc. also rose five spots on the global ranking of retailers in 2013. Now, Whole Foods Market Inc. is in the top 100 of the largest retail chains in the world. I aim to study whether this uptrend will continue in the future. Moreover, I will conduct a detailed analysis of the company's finances and determine whether or not the company is a worthwhile investment.

Historical Performance

Sales increased by 12.14% in the third quarter of fiscal year 2013 to $3,058 million. Average weekly sales grew to $728,000 which eventually increased sales per square foot by 12% to $996. The company expects a growth in per square foot of 8% in fiscal year 2013. Additionally, the company expects a significant year-over-year increase in relocation and pre-opening expenses in the fourth quarter of fiscal year 2013 and the first quarter of fiscal year 2014.

The cost of revenue increased by 11.05% in absolute terms but it decreased as a percentage of sales from 64% to 63.6% in the most recent quarter of fiscal year 2013.This data has been compared to the results of the corresponding quarter of the previous fiscal year. The gross margin increased by 62 basis points in the third quarter of the current fiscal year compared to the margin of the third quarter of fiscal year 2012.The increase in gross margin was primarily attributed to the decrease in cost of revenue as a percentage of revenue.

SOURCE: Morningstar.com

Operating expenses, as a percentage of sales, increased by 6 basis points in the third quarter of fiscal 2013 compared the operating expenses of third quarter of fiscal year 2012. However, despite an increase in operating expenses, the operating margins increased by 57 basis points as a result of higher gross margins in the most recent quarter. Net margins improved from 4.29% to 4.64% in the latest quarter of fiscal 2013 in comparison to results of fiscal year 2012.

The stock reported an 18.75% increase in diluted EPS in the most recent quarter compared to the EPS of the previous year.

Growth Prospects

Whole Foods Market Inc. is America's first national "certified organic" grocer. The following pie chart is a breakdown of market share of organic food. Organic food products with 100% certified organic content lead the market with a 46% share Mean while products with 95-99% captured a 14% market share and 70-94% certified organic content captured 40% .

Organic food that is 100% certified witnessed the highest growth, in market share, with a growth rate of 18%. Meanwhile food that is 95-99% certified grew by 17% and the 70-94% certified category grew by 10%.

The grocery industry is experiencing double-digit growth. On an aggregate basis, the organic products achieved 13% growth across retail channels in the last year. According to a market research report of SPINS, organic products have continued to snatch market shares from the conventional processed products over the last few years. Taking advantage of the shifts in consumer spending, Whole Foods Market Inc. gained around 40% in stock value over the last five months. In such an optimistic scenario, I believe the other players in the industry will also seek to benefit from consumers choosing organic products. Therefore, competition is expected to intensify in the future.

Whole Foods Market Inc. is operating in the most populous cities of the United States. In the United States, customers are becoming more conscious about the food they eat. The growing problem of obesity is prompting customers to question their purchases and eventually refrain from buying unhealthy food items. As customers are becoming more health conscious they will look for affordable and healthier food options. Therefore, I believe that the strong brand name of Whole Foods Market Inc. and its organic product line will enable the company to attain high growth in the long run.

Presently, Whole Foods Market Inc. is offering high-priced products. However, the competitive pricing offered by Sprouts Farmers Market (NASDAQ:SFM) and The Fresh Market (NASDAQ:TFM) have caused Whole Foods Market Inc. to acknowledge its tendency to overprice. Therefore, Whole Foods Market Inc. announced it will set up a test store in Detroit, Michigan. The products in the test store are designed to attract customers from low-income brackets.

Whole Foods Market Inc. currently operates 351 stores. Three hundred and sixty-six stores are located in 40 US states. Whole Foods Market Inc has seven stores in the United Kingdom and eight stores in Canada. Its ability to generate free cash flow is high, With the increasing free cash flows the company hopes to achieve its goal of 1,000 stores. Since they already have 355 stores this goal seems to be achievable in the years to come.

Starbucks (NASDAQ:SBUX) recently announced its collaboration with Whole Foods Market Inc. to increase the market penetration of its Evolution brand. Starbucks has shown confidence in Whole Food Market Inc.'s strong market position and goodwill among consumers. The growing competition in the market offers better opportunities with regards to a number of stores and meeting the demands of consumers. In such a scenario, famous and well-known brands will be more inclined to collaborate with Whole Foods Market Inc. I believe that the collaboration with Starbucks should provide an opportunity for Whole Foods Market Inc. to attract new customers.

The stock has a P/E multiple of 41 times which is well above the industry average of 22.4 times. However, the stock has a PEG ratio of 2.18 times, which is quite below the industry average of 2.89 times. Moreover, the stock has an expected growth rate of 18.71% and is expected to grow over the next five years. This growth rate is higher than the estimated growth rate of organic supermarkets.

Final Call

On a standalone basis, the company's performance improved in the third quarter of the current fiscal year compared to results of the third quarter of FY2012. Whole Foods Market Inc. reported a higher operating margin, net margin and diluted EPS in the most recent quarter compared to results of fiscal year 2012.

Although the stock has a higher P/E multiple than the industry its growth and expected 5-year PEG are lower than the industry average. Additionally, Whole Foods Market Inc. has a wider network compared to its direct competitors. Moreover, due to the increasing trend of customers switching to organic food, I believe that Whole Foods Market Inc. will continue to outperform the market. I recommend buying the stock.

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.