by David Urani
On Sunday December 12, one of the icons of the grocery business, The Great Atlantic & Pacific Tea Company, better known as A&P (GAP) officially went down after filing for Chapter 11 bankruptcy protection. One of the pioneers of the supermarket industry, A&P used to be the market leader, and in the 1950's it generated greater than 20% more sales than the nearest competitor. Over the past couple of years, particularly with the onset of recession in 2008, the supermarket industry has taken a tough turn, however. Discount grocers have been in the middle of a heated price war, which along with volatile food prices, has constricted gross margins industry wide. One could say that A&P was a high profile casualty of this pricing war.
That being said, A&P was also a victim of its own underperformance and a shift to the modern age. Starting in the 1940's, the industry began the switch from smaller stores to supermarkets. After having more than 15,000 stores in the 1930's, it consolidated into 4,682 larger markets by 1949. Perhaps it was the right move to adapt to the changing market, but by the 1960s it was becoming apparent that A&P was being surpassed, and that store base would continue to shrink over the next several decades. A shift to suburban shopping and national brand name store items left the Company out of the loop, with pressured revenues and falling profits. By the 1980's, the Company had restructured and ran fewer than 1,000 stores. By the time A&P took the final plunge into bankruptcy, it was operating just 395 stores across the nation. So as you can see, A&P has generally fought a long, losing battle for decades now, with the latest price war being the final nail in the coffin.
A New Market Emerges
Whole Foods Market (WFMI) is a pioneer of the new era of supermarkets. Whereas A&P's decline really began with the shift to the new national supermarket model in the 50's and 60's, Whole Foods represents the next shift beyond that in the growing market for healthy foods. With the acquisition of Wild Oats in 2007, Whole Foods became the undisputed champion of the loyal health-conscious market.
Say what you will about Whole Foods being a "premium" grocer, it commands a loyal market niche in both good times and bad and sales never suffered as badly as people expected with the onset of economic gloom. And, with some optimism returning to the wallets of consumers, Whole Foods has only accelerated its momentum. As Kroger (KR) and Wal-Mart (WMT) battle it out to lure in the bargain shoppers, Whole Foods has remained surprisingly well outside the crossfire. According to the Organic Trade Association, organic food sales increased by 5.1% during 2009 versus the 1.6% increase for all food, which illustrates consumers' willingness to pony up for higher quality.
With a gross margin of 34.6% in its fiscal fourth quarter, it is the industry leader, and it also represented an improvement year over year of 40 basis points, largely as a result of improving economies of scale as it expanded operations. Although gross margin was indeed modestly lower quarter over quarter, its sales growth (+14.7% Y/Y) has been enough to offset any near term weakness on the bottom line. Additionally, overhead costs controls have paid off. Those factors in combination led to a $0.05 per share beat versus consensus estimates in its fiscal fourth quarter.
And then there is the icing on the cake, which is the fact that Whole Foods is far from fully penetrating the health food market. Given its highly recognizable brand name, you might be surprised to hear that Whole Foods currently only operates 301 stores worldwide. But make no mistake, management is out to change that, having opened 16 stores in fiscal 2010 through $90 million of capital spending. In fiscal year 2011, the Company intends to ramp spending up to approximately $140 million. And, with strong operating cash flow (more than $120 million in fiscal 4Q10) it has the resources to keep building (it even reinstated a quarterly dividend of $0.10 per share). Therefore, it should be seeing good sales growth, both organically (pun not intended) through existing stores and inorganically through new stores.
Although the near term difficulties in the supermarket sector are likely to stick around for a while, Whole Foods is turning in industry leading performance metrics. Meanwhile, it has the most to gain in the long term.