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Summary

  • Whole Foods Market is down over 20% from its high late last October.
  • Wal-Mart's deal with Wild Oats is a bogus threat.
  • Whole Foods Market's cannibalization story has its positives.

Depending how you look at the stock market, Whole Foods Market (NASDAQ:WFM) is either having a great year or a terrible year. The stock is down over 20% since its high last fall, likely due to their lower earnings estimates for 2014, their so-called "cannibalization" effect that occurs with new store openings, and the recent announcement of a Wal-Mart (NYSE:WMT) and Wild Oats deal. A slightly deeper look into any of these issues will leave the thoughtful investor reminiscing the words of FDR, before he began ruining the nation's economy: "The only thing we have to fear, is fear itself."

A Little About Cannibalization

When Whole Foods Market opens new locations within a close radius to their other stores, it tends to bring down sales at existing stores. This could be due to shoppers at one store making a trip to check out the new store (love for the brand). It's also largely due to the obvious dilution of the market in the area. After roughly one year, however, the comparable store sales have historically rebounded in what John Mackey, Whole Foods Market co-CEO, identified as "a sling-shot effect." Whole Foods Market opened 32 stores in its last fiscal year, and is already on its way to open up to 38 this year, and 40 in 2015. As of November 2013, it had 94 new leases already secured for future stores.

Opening new locations at such a fast rate creates even more cannibalization risk. So, where is the rationale? Unbeknownst to much of the public, there is a race for placement happening in the natural foods industry. Whole Foods Market is acting wisely by using its resources to grab up and secure as many long-term leases for choice locations as it can. One more thing: They'll be able to open all the new stores with cash.

A Little About Wild Oats and Wal-Mart

I would consider it obvious to bet on the pioneer of natural foods, with the $18 billion market cap, over a competitor it once purchased for a figure on par with its net income for 2013. Some investors, however, fear that customers once loyal to the Wild Oats brand will leave Whole Foods Market in its favor when it settles into its new home. Most of the old Wild Oats shoppers have instead found Whole Foods Market to be a superior shopping experience for organic and natural foods. This is likely because Whole Foods Market not only provides the best products available, it also takes care of its workforce, and in doing so found itself again on Fortune's list of "100 Best Companies to Work For."

Whole Foods Market also has great strength with their vendor partnerships, and are committed to expanding value offerings in their stores. The shopping experience at Whole Foods Market is rated high and has been a huge driver in their growth. Wal-Mart is also used to receiving awards, though they're more often in "worst customer satisfaction of any retailer," according to their American Customer Satisfaction Index (ACSI) rating.

Whole Foods Market and the Broader Industry

In addition to its plans to rapidly open new stores, Whole Foods' comparable stores sales growth has averaged over 8% for the last 15 years. Natural foods sales have been growing 10% annually according to Natural Foods Merchandiser, and the broader supermarket industry grew 3% last year. As the natural and organic market continues to outpace the broader supermarket industry, due to more people becoming aware of its benefits, prices will begin to come down. These products will likely begin to take up a larger portion of supermarket retail space, and leaders in the industry with the superior shopping experience will beat out their competitors. Arriving late to the game -- 30 years late -- isn't a huge competitive advantage.

Note to Medium-Term Traders

For all eight quarters of 2012 and 2013, Whole Foods Market stock fluctuated between 16% and 27% on the upside. The stock is currently at an 11-month low.

Conclusion

The highest quality products, excellent shopping experience, committed team member workforce, three decades of experience in natural foods, focus on value offerings, new store growth, comparable sales growth, lack of debt, and strategic placement of its locations provide Whole Foods Market quite a moat to defend against potential threats. While cannibalization may cause temporarily adverse effects on sales, it is not an enduring issue. With or without Wild Oats, Wal-Mart has a long way to catch up with Whole Foods with natural and organic food, and will likely experience numerous flat tires on the way. Thankfully, we can always rely on frenetic investors to create favorable buying opportunities out of great companies, even in high markets.

Source: Whole Foods Market Pessimists Are Heroes To Smart Investors