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Summary

  • Whole Foods has drawn a lot of attention with a 30% drop over the past three months, and could represent a buying opportunity.
  • Sprouts Farmers Market, The Fresh Market, The Kroger Co., and Whole Foods Market will all be compared against fundamental analysis and statistics.
  • Specialty Retail is highly competitive, and research should be done to find a "best of breed" company.

The second quarter sell-off experienced by Whole Foods Market (NASDAQ:WFM) stood out to me. The company reported earnings per share 7% off estimates, and a consequent 30% drop has followed since. Whole Foods has been a great growth story that tells the tale of good, old-fashioned American capitalism where employees earn benefits and bonuses as part of the team ("Gainsharing Program" discussed shortly), and CEO John Mackey earns a $1 salary, literally writes the book on being a "conscious capitalist" and wants employees, customers, and everything in between to prosper. This is the Whole Foods experience that I had heard about, so following a sell-off, naturally I wanted to dig a bit deeper to find out what exactly Whole Foods is about and if there was a buying opportunity. Yet, I found that the specialty retail story is a bit harder to understand based on one company alone. So after reading through four different annual reports and some quarterly earnings, it seems that in a highly competitive sector, along with an economy that favors the individual stock-picker, the importance of the "best of breed" company reigns.

What will follow are statistics on (1) number of stores (from latest annual report), (2) expected new stores for fiscal year 2014, (3) Average store square footage, (4) 2013 revenue per square foot, and (5) Differences between each store, as well as some comparable financial statistics and an overall consideration of economic conditions for these organic specialty retail stores.

Sprouts Farmers Market (NASDAQ:SFM) - The Freshest Pick

Sprouts Farmers market is the newest of the organic specialty store companies, with an IPO in August 2013. Sprouts has 167 stores across 8 states, but mainly in the southwest, from California to Oklahoma. Founded in Arizona, Sprouts has shown tremendous growth, with the company's annual net income shooting up 163% from 2012 to 2013. The company expects to open an additional 22-24 stores in 2014. Sprouts deliberately chooses to have what they call a "small box format," a small store that averages 27,442 square feet (We have all been to a Wal-Mart, right? For comparison, an average Wal-Mart is about 102,000 square feet). With 2.437 billion dollars in 2013 revenue, that amounts to generating $531.97 of sales per square foot.

The company is by far the youngest of the competitors, which could mean that they have the most room for growth through store expansion. In addition, the company has a very specific layout for its stores, and has a straight-forward business plan for management and the company uses local suppliers (over 800) along with Nature's Best, Inc. and United Natural Foods (NASDAQ:UNFI). You can find Sprouts' 2013 Annual Report here.

The Fresh Market (NASDAQ:TFM) - Another Organic Option

The Fresh Market boasts 151 stores (not as many as Sprouts) but across 26 states...mostly in the southeastern U.S. and with the most stores in the state of Florida (33). With over 1000 suppliers and a similar "small-box format," The Fresh Market averages 21,000 square feet per store. In 2013, the company generated $1.511 billion which equates to $472.39 per square foot. In this case, it seems that The Fresh Market has smaller stores than Sprouts, but also generates less sales per square foot. Both annual reports were similar due to the likeness of their store layout and business plan. However, it should be noted that The Fresh Market specifically stated it will add 23-25 new stores in 2014, but no more than five in California and Texas. Also, The Fresh Market's 2013 net income was up 24.7% from 2012 - so again, there is room to grow, but it is a very similar story to Sprouts Farmers Market. You can find The Fresh Market's 2013 10-K here.

Kroger Co. (NYSE:KR) - A competitor, but of a different model

Kroger is a much larger company compared to the previous two, and is actually more similar to a Safeway or perhaps even Wal-Mart. Kroger has 2,640 supermarket and department stores under several different brands, including CityMarket, Dillons, Food 4 Less, Fred Meyer, Fry's, newly acquired Harris Teeter, and others. Kroger is also different because of its diversification in retail and food stores, multi-department stores, jewelry stores, convenience stores, and many of its supermarkets sell gas as well. But nevertheless, it stands as an outside competitor to organic specialty stores, and with 76.6 billion dollars in 2013 revenue, that amounts to $476.18 of sales per square foot (strictly in its food stores). Kroger differs from the other companies because of its unionized workers (Sprouts, The Fresh Market, and Whole Foods are all non-union) and pension plan obligations. This company is relevant to the discussion because of recent news in more stores offering organic food, but depending on the demographic you believe shops for organic food, Kroger may not be in the same category as the other three companies. You can find Kroger's 2013 10-K here.

Whole Foods Market - The Organic Bellwether

Of the four companies discussed, Whole Foods Market is the only one with international presence. With 362 stores after 2013 that stretch across 40 states, eight of them are in Canada, and seven of them reside in the United Kingdom. Whole Foods has over 2000 suppliers (again because of the influence of organic and locally sourced products), but 32% of the company's supply comes from United Natural Foods. Whole Foods stores average 38,000 square feet, so their stores are bigger than both Sprouts and The Fresh Market, and with 12.9 billion dollars in 2013 revenue, the company enjoys $937.44 in sales per square foot - more than any of the above companies (if you are paying attention to quarterly reports, you should know that this number has grown to $1000 per square foot). Whole Foods had an annual increase in net income of 18.2%; but what stood out to me as I read through the report is the emphasis on employee success and community involvement. Looking closely at the company's latest 10-K, there is a "Gainsharing Program" - if an individual store comes in under budget over a one month period, that surplus is then added to a savings pool that is paid out to employees annually:

Team members are involved at all levels of our business. We strive to create a company-wide consciousness of "shared fate" by uniting the interests of team members as closely as possible with those of our shareholders. One way we reinforce this concept is through our Gainsharing program (2013 10-K pp. 7)

Part-time and full-time employees also have the opportunity to receive stock-based compensation. Whole Foods also has an intense social media presence, and has over 20 trademarked programs (such as "WholeKidsFoundation" and "WholePlanetFoundation" that give charitable donations) which presumably help to maintain presence in the community. Reading each annual report, Whole Foods was definitely a stand out. However, because of the highly competitive nature of the specialty retail industry, can a conclusion be made that the Whole Foods "feel good," good place to work story translates into profits and earnings? You can find Whole Food's 2013 10-K here.

There are a few more key statistics to consider:

SFM

TFM

KR

WFM

Gross Margin (latest quarter)

31%

34.4%

20.9%

35.9%

Dividend

-

-

1.3%

1.2%

Same Store Sales Growth (latest quarter)

12.8%

2.5%

4.6%

5.0%

P/E

68.31

32.11

17.57

24.79

Short Interest (% of float)

8.39%

1.7%

2.1%

9.73%

(Short Interest: Nasdaq Short Interest)

(All other info: Source: Yahoo! Finance. P/E ratios are subject to change)

(Quarterly Reports: SEC Edgar Database)

If you choose to ride the specialty retail roller coaster, with all the changes in earnings and possible outcomes, then hopefully you regard margins as an important indicator. Whole Foods sports the largest margin...but comparable store sales growth may be just as important. If this is the case, then Sprouts is the way to go. I have also included the short interest, which can indicate that there is opportunity for stock price movement.

One Last Loop in the Roller Coaster, and a Conclusion

All four companies sell similar products, and therefore are susceptible to broad economic outcomes. The first consideration would be inflation. If inflation rises, then suppliers would demand more cash for their products, which in turn could hurt the margins for each company. On the same note, it could be worth checking commodity prices for standard staples (corn, wheat, coffee, cattle, even oil) - were there to be a rise in commodity prices, the margins for these companies would again be squeezed. For example, if California experiences a severe drought (which it currently is), and if Whole Foods and Sprouts each have multiple stores in the state, there could be scarce resources for produce and perishables, leading to higher prices for each company to absorb. As an investor riding the retail roller coaster, there are many factors to consider.

From my individual perspective, Whole Foods Market has been a stand-out company with a unique approach. Given the company's past performance, it is easy to see they can continue to grow despite a competitive environment. In the coming quarter, I will be looking specifically at gross margins and net margins, in addition to earnings and revenue. But depending on what an investor values, their personal "best of breed" company may be different...there may be other opportunities to seek.

Source: Whole Foods, Sprouts, The Fresh Market, Kroger, And The Retail Roller Coaster