The Whole Story On Whole Foods Market, Inc.

| About: Whole Foods (WFM)

Summary

Whole Foods Market operates natural and organic foods supermarkets and has greater than 430 stores.

Whole Foods Market has always made a commitment to top-notch natural and organic foods in its stores.

The Company’s product lines include 365 Everyday Value products; Whole Foods Market products; Engine 2 Plant-Strong Products; and products with its Whole Trade Guarantee.

For Q4 2015 (ended September 27, 2015), Whole Foods Market’s sales grew 6 percent to $3.4 billion – a record.

The Company is looking to build sales and market share with its new “365” initiative.

whole foods There's been a lot of press in the past year on Whole Foods Market, Inc. (NASDAQ:WFM) and it hasn't all been good. From the Company experiencing significant increased competition in the natural foods and organic space, to the allegations that Whole Foods Market stores were charging customers too much for prepackaged foods. Add to that its drop in same-store sales numbers and investors can see that the Company has its issues.

Reading some press, you would think that all is negative for Whole Foods Market. Certainly the same-store sales drop is troubling. However, other metrics do look good for Whole Foods Market. I think it's time that investors really look at the whole story as concerns the Company before coming to any rash investing conclusions.

Whole Foods Market (based in Austin, Texas) operates natural and organic foods supermarkets and has more than 430 stores. The majority are in the United States (across 42 states) while other outlets are in Canada and the United Kingdom. The Company's product lines include 365 Everyday Value products; Whole Foods Market products; Engine 2 Plant-Strong Products; and products with its Whole Trade Guarantee.

The competition

One of Whole Foods Market's major competitors is Sprouts Farmers Market, Inc. (NASDAQ:SFM) with a market cap of 3.94B. Whole Foods Market's market cap is 10.94B. Sprouts Farmers Market is a specialty retailer of fresh, natural, and organic food in the U.S. It is a full-line healthy grocery store and has in excess of 17,000 fresh, natural and organic products. As of November 5, 2015, it has 216 stores in thirteen states.

The natural and organic foods market

Consumers today want quality natural and organic food products that help them achieve "clean eating." Food Business News (www.foodbusinessnews.net) reported in its article "Diet trends forecast: Kale out, clean eating in" (December 30, 2015 - Monica Watrous), that "Trending superfoods for the coming year include seeds, avocados and ancient grains, according to more than half of registered dietitians surveyed. Kale has lost its luster, and green tea is gaining steam."

Furthermore, consider that Nestle S.A. is focusing on becoming a nutrition, health and wellness leader. The Company is doing more than just reducing salt, sugar and fat in its products. In 2014, it reformulated 1,058 food products and pet products to consider nutrition or consumer preference. This included reduced sodium, sugar, trans fat and artificial colors and flavors. In addition, Nestle increased essential nutrients.

Whole Foods Market has always made a commitment to top-notch natural and organic foods in its stores - the rest of the retail food and consumer packaged goods industry is now catching up. Imitation is the sincerest form of flattery it's said. The objective now for the Company is to be inventive to maintain a leadership position in the food sector with the increased competition out there. Its focus is on being different with superior quality products - striving to be better than its competition with its products, such as its perishables. This is from its animal welfare system in meat, to its sustainable seafood, to its responsibly-grown produce.

Of note (regarding the natural and organic foods sector) is that Co-Chief Executive Officer & Director Mr. John Mackey said in the Company's Q4 Earnings Call that "…our tremendous success has bred increased competition." The Company's responsibility to its shareholders is to innovate in the ways it meets this competition head-on.

Sales

For Q4 2015 (ended September 27, 2015), Whole Foods Market's sales grew 6 percent to $3.4 billion - a record. However, comparable store sales (same-store sales) on a constant currency basis declined slightly at 0.2 percent. Comparable or same-store sales is an important number for investors as it enables them to ascertain what percentage of new sales has come from sales growth and what percentage is because of new store openings.

It's vital for a retail company to continue to mine sales from established stores open a year or more. This is a sign of strength in the retail sector as a whole and in a company's specific retail market segment - their foundation stores are continuing to drive growth. So, yes, this is, as I stated above, a bit of a troubling metric for Whole Foods Market. However, Whole Foods Market has developed its business to be close to $16 billion annually in sales.

What is the Company's strategy to combat this drop in same-store sales and grow traffic and sales? It is continuing to focus on its commitment to product quality and choice for its customers. Additionally, Whole Foods Market will engage in "selective and strategic price reductions" - not involving itself full-scale in profit eroding discount price wars, which could erode its image as a purveyor of high-quality, premium foods.

Its customers see Whole Foods Market as a leader in the natural/organic space with a substantial selection of first-rate products that they are willing to pay more for. So, the Company said it will invest "strategically and systematically" via promotions and lower prices in product categories it sees fit to do so.

The Company is looking to build sales and market share with its new "365" initiative. Its "365 by Whole Foods Market" program is its complementary brand. The goal with 365 is to extend to new markets and customers to grow sales. This program is geared to millennials (people who reached adulthood on the cusp of the 21st century) and the Company will open three "365 by Whole Foods Market" stores this year and up to 10 locations by 2017. (Food Business News Magazine {Print Edition} - Dec. 1, 2015 - pg. 25).

The 365 stores will carry a smaller range of products. The stores will be on average 43,000 sq. ft. The expectation is that these stores will produce higher 'Returns on Invested Capital' (ROIC) than traditional Whole Foods Market stores. The Company has 114 sites on slate for its "365 by Whole Foods Market" banner. Its 365 banner will serve communities that the Company would not be able to reach with its larger Whole Foods Market supermarkets.

The 365 line is similar to Kroger's "HemisFares" product line for "foodies" (those who have a strong interest in the latest food trends). 365 products include organic frozen fruits, organic broths, organic stuffing mixes, whole grain flowers, organic milk, shade-grown coffee, and even organic pumpkin pie ice cream sandwiches and organic sweet & salty kettle corn, among other products.

Concerning, Kroger (NYSE:KR), each of its HemisFares products is channeled from the original source and imported directly to Kroger retail stores. So, both companies are catering to individuals who want innovative, first-rate quality products not always found in your average supermarket.

Whole Foods Market is aiming at sales growth of 3 to 5 percent for this Fiscal Year. It is also targeting square footage growth of 7 percent or more and the opening of roughly 30 new stores.

Return on Invested Capital

For Fiscal Year 2015, Whole Foods Market generated a 15 percent Return On Invested Capital. It believes that "365 by Whole Foods Market" will help this metric. Sprouts Farmers Market's ROIC (trailing twelve months) was 12.44 percent for Sept. 30, 2015.

The ROIC number indicates profitability and if a company is using its capital efficiently. Essentially, ROIC expresses how much cash is coming into a business versus how much is going out of a business. Is a company generating robust returns from its investments as it works to build growth? Whole Foods is performing well in this category.

Operating Margin- Net Margin

At September 30, 2015, Whole Foods Market's operating margin was 3.76. Sprouts was 3.66. Whole Foods' net margin was 3.48 on September 30, 2015 and Sprouts was about the same at 3.49.

Debt-to-Equity

Whole Foods Market's debt-to-equity was very good at 0.02 for the period ended September 30, 2015. Sprouts was 0.34 for the same period. This low number for both companies is good because it means less risk for its businesses.

For example, a debt-to-equity ratio of 1.00 means that 50 percent of the assets of a company are funded by debts and 50 percent by shareholders' equity. Therefore, a number less than 1.00 means that more assets are funded by money of shareholders than those funded by debt - hence the reduced risk.

Cash Flow

For Q4 2015, Whole Foods Market had strong cash flow from operations of $132 million. The key takeaway here is succinctly expressed in John Mackey's statement in the Company's November 4, 2015 Q4 2015 Earnings Call, when he stated that this robust cash flow was "in our seasonally slowest sales quarter of the year." So, despite this seasonally slowest sales quarter, the Company still has the continuing ability to generate and use cash.

It behooves investors to study a company's operating cash flow. This metric gives insight into an entity's ability to generate cash from its normal daily operations. It's an indication of a business' liquidity.

Furthermore, Whole Foods Market's Price/Cash Flow for the most recent fiscal year (MRFY) is 11.16 and the industry average is 7.77. Sprouts Farmers Market has a very strong Price/Cash Flow (MRFY) of 22.08. Price/Cash Flow compares a company's market price to the amount of cash flow it produces on a per-share basis.

For Fiscal Year 2015, Whole Foods Market generated a very healthy $1.1 billion in cash flow from operations, which is a record. Glenda Jane Flanagan, Whole Foods Market's Chief Financial Officer & Executive Vice President said, "...we have very strong cash flow and are very confident in our ability to service the debt and to continue to fund our growth out of our own cash flow."

An Efficiency Ratio: Inventory Turnover

Whole Foods Market's inventory turnover ratio was 20.45 for the period ended September 30, 2015. Sprouts' was 15.72 for the same period. Whole Foods is more resourceful when it comes to the number of times per period it sells and replaces its complete lot of inventories. A higher inventory turnover ratio indicates efficiency of operations.

Net Profit Margin

Whole Foods Market's Net Profit Margin (trailing twelve months) is 3.48 percent. Sprouts Farmers Market's is about the same at 3.49 percent for the trailing twelve months. The industry's is 2.54 percent for the same period. Both companies are performing better than the industry average here. Net Profit Margin shows what fraction of revenue transferred to the bottom line. This is a part of quality fundamental analysis that investors must consider when analyzing companies.

Return on Assets (ROA)

Whole Foods Market's Return on Assets (ROA) for the period ended September 30, 2015 was 9.72. As a comparison, its competitor Sprouts Farmers Market's ROA for the same period was 8.86. This is a profitability ratio and it measures a company's efficiency in utilizing its assets to produce net income. A higher ROA number indicates that a company is more profitable.

Return on Equity (ROE)

Whole Foods Market's Return on Equity (ROE) (trailing twelve months) is 14.63 percent. The industry's ROE (trailing twelve months) is 20.80 percent.

The Company's ROE for the period ended September 30, 2015 was 14.63. Sprouts Farmers Market's ROE for the same period was a better 16.46. This ratio is a measure of profitability of shareholders' investments. Again a higher number here is preferred. A higher ROE means that a business is efficient in generating income on new investment/financing. Both companies are generating income but have some work to do to meet the industry trailing twelve months' number.

Dividends

Whole Foods Market is a dividend paying food retailer. The Company's dividend yield is a modest 1.69 percent. It has returned roughly $2.4 billion to shareholders via dividends and share repurchases since 2011.

In November 2014, its Board of Directors declared a 4 percent increase in the quarterly dividend to $0.135 per share from $0.13 per share. This is its fifth consecutive dividend increase since reinstating the dividend in 2011.

Technology programs

Whole Foods Market will put money into digital initiatives as it works to transform the strong traffic it generates online into actual sales. Furthermore, it will put in place one Point-of-Sale (POS) system to all U.S. stores by the end of this calendar year. The goal with this program is to provide faster checkout times, improved labor productivity, and improved data visibility across all channels.

In addition, it's involved in a partnership to co-create a next-generation cloud-based retail, merchandising and supply chain management platform. The Company says that this platform will bring it numerous new competencies. This includes perpetual inventory, replenishment, retail space planning, as well as price optimization.

The allegations and the response

The Wall Street Journal reported on December 28, 2015 that Whole Foods Market "…has agreed to pay $500,000 and enforce certain policies to settle allegations that its stores were overcharging customers for prepackaged foods, the New York City Department of Consumer Affairs said Monday." The agency's investigation did not find evidence of "systematic or intentional misconduct" by Whole Foods Market.

Whole Foods Market co-founder and co-CEO, Mr. John Mackey said, "The New York (City's Department of Consumer Affairs) event (saying we overpriced items there), was making a mountain out of a molehill in the sense that every year in every city you are going to have weights and measures mistakes and that's true of every supermarket of America."

He further said, "Then, you have the infamous ($5.99) asparagus water. Do you realize… we only sold one bottle of asparagus water in one store that was mispriced? And the guy who did the pricing, it was his first day on the job. And it was national news. And I think trying to get that corrected, no one was interested. It was very frustrating for us." (Austin American Statesman - By Claudia Grisales Austin American-Statesman, The Buffalo News, Top Stories - Whole Foods Fights Back - January 2016).

Further points to consider

a) On the downside, the Company is anticipating a decline in operating margin of up to 75 basis points from the 6.1 percent it reported last year (excluding charges). This will be because of the cost of programs to build traffic and sales, higher occupancy, depreciation and other expenses. On the upside, the point here is that the Company is engaging in expenditures to drive traffic and sales, which is something investors should take note of.

b) Nonetheless, also of note is that for Fiscal Year 2015, Whole Foods Market generated industry-leading sales per gross square foot of $970. It believes it can increase this figure. Moreover, the Company's concentrating on its exclusive brands and prepared foods, which account for approximately one-third of its sales. These brands and foods appeal to millennials and foodies and others who take more than a passing interest in the source of their foods and the inherent quality as well. It's a customer niche not to be ignored and Whole Foods Market isn't ignoring them.

c) The Company also has a new "out-of-stock" tool. It's been put in place across all its stores. This is to ensure that its customers can always buy the products they desire when they visit a Whole Foods store. This should contribute to more sales because of solving the empty shelf phenomena (through deficient inventory tracking) that hurts retailers.

d) Regarding e-commerce, the Company has attained the $2.5 million mark - its average sales of its last four weeks as of the date of its Earnings Call on November 4, 2015. It is working to build its e-commerce sales to drive its business forward and meet the demands of online shoppers. Whole Foods Market has 6 million visitors monthly to its web portal. The Company's Instacart partnership provides fresh grocery delivery to more homes in the United States than any other food retailer.

e) Furthermore, the Company is gaining efficiencies in its overall cost structure. Its intention, with a plan in place, is to reduce its expenses by a $300 million run rate by the close of FY 2017.

f) Whole Foods Market sees potential for 1,200 Whole Foods Market stores in the U.S. It believes the new "365 by Whole Foods Market" format will expand this growth opportunity beyond 1,200 stores.

g) Finally, Whole Foods Market has been ranked for 18 consecutive years by Fortune magazine as one of the "100 Best Companies to Work For" in America.

Conclusion

The jig is not up for Whole Foods Market by any means, no matter what naysayers trumpet. A further look at the Company says otherwise. Am I saying to run out and buy Whole Foods Market shares. No. I'm saying that sometimes you have to differentiate from titillating market news meant to sensationalize one negative aspect of a company (re: same-store sales) and look deeper into (i) their overall operations, (ii) remedies to turn their business around, (iii) upcoming initiatives to drive growth, (iv) and more than one key financial metric, which give a more well-rounded picture of a business. This is especially true for entities that operate in the highly competitive and volatile retail space.

I believe that Whole Foods Market has significant challenges ahead, but also the fundamental financial strength and driven, proactive management to get things done and put the company on the upswing once again. I dislike the rampant negativity in the press and sometimes even on Wall Street, all ready to quickly jump on companies who experience difficulties.

I like to give the benefit of the doubt to quality companies who strive to overcome difficulties, economic gyrations, and fight tooth and nail to get their business back afoot - no matter what industry. That's just how I think as an investor and I will continue to think that way and invest as I see appropriate - with patience for companies like Whole Foods Market, Chipotle Mexican Grill, Inc. (NYSE: CMG), and others facing tough issues in ultra-competitive industries.

Whole Foods Market is not looking at its business, competition, and the retail food sector through rose-colored glasses. The first thing a company has to do when facing challenges is to be a fighter and know what they're in for, and then charge ahead boldly, while being realistic. As the Company's John Mackey said, "I want to underscore that we recognize we have our work cut out for us."

Disclosure: I/we 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.