Whole Foods Market Is Finally Learning A Lesson

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The first quarter of 2014 was strong despite missing the benchmark. Higher sales were achieved despite bad weather affecting economic activity. Costs remained under control with the company introducing modifications.

The price reduction strategy that Whole Foods is adapting together with bringing an increased product offering and targeting pretested brands will help it to gain a bigger market share.

Advertising and GMO hype will favor growth for the company as it aggressively expands its store base.

Whole Foods Market Inc. (WFM) has stumbled somewhat during the last 6 months and this is partially explained by the company missing its benchmark sales growth during its last quarter. However, the current picture is not bad as it seems. There are plans going on that may help this once rising stock to return to where it once was. Until then, it provides a decent opportunity to investors who want to buy the share at a depressed price.

In this article we will go through Whole Foods' first quarter performance of 2014. Then, I'll take you through some plans that I believe will help the company to getting back on its feet.

First Quarter, 2014

The Results were Good and the Company Broke its Seasonality Barrier

Source: 10Q

During the quarter, Whole Foods increased its sales by almost 10% to a record $4.2 billion with comparable store sales increasing by a 5.4% and coming just a little below the company's annual target. The results were driven by higher transactions (3.1%) and a bigger basket size (2.3%) at the beginning of 2014 which would have been higher if the US had not been impacted by severe winter weather that affected shopping patterns with customers making fewer trips.

The gross margin remained stable at 35% however it managed to increase 6 bps during the quarter compared to the same period a year ago. The increase was the result of leverage in occupancy cost that was partially offset by a slight increase in the cost of goods sold as a percentage of sales neutralizing the net effect. The cost of sales component was altered by the company enacting some improvements that I believe will give Whole Foods a good advantage in the future.

Another major cost for the company was direct store expenses that also remained stable at 25.4% of total revenue this quarter owing to a decrease in wages offset by an increase in health care costs as a percentage of sales.

Higher sales with relatively stable costs brought about a 7% increase to diluted EPS which came at $0.42. The good thing for Whole Foods was that it managed to raise its sales during the quarter despite being disrupted with macro-economic factors. This sales momentum may continue with the company's strategy modification.

The Future

Price Alteration will help Whole Foods Gain a Bigger Market Share

Whole Foods is putting efforts into distancing itself from the luxury image it has portrayed in the past. This image is one of the reasons why the company has been preferred by few rather than flocks that have favoured cheaper alternatives such as Walmart (NYSE:WMT) during the recession. The 106 bps moderation in average price per item growth the company brought during the first quarter was an initial step towards improving the relative price position of Whole Foods in the market.

The focus on improving price competitiveness primarily within the grocery department will prove to be the right choice given the company's high sales in the division. This move along with expansion within the perishable area will provide value range as well. The addition of more high-grade conventional offerings in produce to complement the organic offerings will allow customers a broader range of choices.

Lower Prices Plus Quality Food Equals Strong Positioning

Also, maintaining a high quality of standards along with an improved range of products at lower prices will undoubtedly differentiate Whole Foods from its competitors. Additional plans such as offering fresh packaged chicken in all of its U.S. stores under the 365 Every Day Value brand will pave the way for growth from areas that are pretested. The 365 products previously became best sellers in most of the company's grocery classes therefore I can expect the newer additions to show similar results.

All of the above measures will finally be supported with the increasing promotional activity that will then redesign the brand image that Whole Foods is trying to alter. This advertising will be effective because the GMO hype is already everywhere on the news. The only factor that prevents consumers from shifting towards healthier choices is the higher prices. Now, with Whole Foods pushing their prices down and marketing this discount heavily consumers will soon flock to the company's superstores.

Store Openings Are a Sign of Whole Foods' Confidence in its own Abilities

Source: 10Q

The company plans to open 13 new stores by the end of the second quarter of this year. For the other half it will open 20 to 25 stores. The openings will continue in 2015 where Whole Foods will add another 38 to 45 stores hence synchronizing itself with its long-term target of owning an operating base of 500 stores by 2017.

Such a high pace of development reflects the confidence of the company in its future growth prospects. The openings are likely to increase the company's operating costs in the near term bringing a slight dent to earnings but this shouldn't be a cause of worry as everything is being done in accordance to help investors in the longer term.

Bottom Line

It's not a big deal if a company misses its benchmark as long as it is going in the right direction. This is the story with Whole Foods and it experienced a 13.3% return on invested capital last quarter. Revenue growth for the last 3 years has averaged 12.8% higher than the industry's 1%; the margins have also increased in the past twelve months. All of these factors lead me believe that Whole Foods offers a good growth potential especially after learning its lesson of charging higher prices. Therefore, I recommend a buy rating for the company.

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.