By Dan Myers
Before you read this article, read Jae Jun's article on Whole Foods (WFM).
Whole Foods is one of those companies that has made me a better investor and person because I took the time to learn about the company. I am not the one that does the shopping in my house and I am certainly not the dietician in my house. I eat a lot of garbage.
So this weekend, I was going through an informal screen, A.K.A goofing around in the web. I found a list of debt free companies. I've seen these lists before and started to scan. Most of the companies on there I like, but are just flat out too expensive.
However, I saw Whole Foods on the list. I found this odd and I also remembered an article coming out from OSV about Whole Foods. I honestly didn't read beyond the title. I was intrigued.
I went back and reread the thesis. Here are the 3 ideas I got from it:
- Wal-Mart is not a threat
- CAPEX is evenly mixed between maintenance and growth
- The company is only beginning to ramp up its growth plans
The conclusion was that Whole Foods was fairly valued and is one you should just buy and sit on for the long haul. After doing some more digging, I have to disagree. This company is undervalued and this is a prime time to buy.
Why I Bought Whole Foods Market
There are 3 things I found that made me want to buy.
- No Debt
- Growth is slow now compared to their goals
- They have a pioneering culture
No Debt: The Only Way I Shop
I'm going to continue to beat on this idea. Companies with no debt are more financially nimble and able to focus on shareholder value, not banker value. Whole Foods has no long-term debt.
This is from ValueLine:
WFM Capital Structure | Source: Valueline
The only long-term obligation is $31 in capitalized leases. Their leases are all in their operating expenditures. Also, with the stock price taking a hit, they are poised to buy back shares at this discounted rate. That certainly helps reduce the risk as a shareholder. Cash Flow is actually free and not promised to the bank.
The downside to no debt is that Whole Foods has had to dilute its shareholders a little. Whole Foods has sold shares on net for about $1.3B over the last 10 years. The worst part is that it sold over $400M of that in 2009 when the stock was at its lowest. This is a concern and is dilutive to the shareholder base.
The Growth Story is Only Just Beginning
In 2014, Whole Foods is expected to open another 33-38 new stores. Currently, it has about 360 stores. Per this Forbes article, Whole Foods wants to open an additional 1,000 stores in the next decade. Granted, these stores will be smaller, but that is almost tripling in size in a decade.
For arguments sake, let's say the new stores are 50% the size of the existing portfolio. That is the equivalent of 500 same size stores in a decade. That would be 50/year. Whole Foods is currently at 33-38. It needs about another 33% bump in our current build rate to meet that goal. That's reasonable. Whole Foods is accelerating the growth without getting ahead of itself. Also, Whole Foods hasn't had to finance its expansion in several years. It has all been done organically (there is a pun in there somewhere). If I use 50/year, that comes to an annual 9% growth rate in store equivalents. This is just store growth. I haven't discussed additional customers per store.
The trend is clear that people want to eat healthier. This expands their market and another 2% growth rate in same store traffic is reasonable as more people decide to eat healthier. One new Whole Foods shopper for every 50 in an existing store sounds reasonable just on population growth.
Additionally, factor in price inflation. The food industry is going through an inflationary time. The question for grocers is whether or not they can pass on the price increases they are seeing to their customers. If a company can pass along their inflation, then you can tack inflation on to their growth rate. I look at gross margins for this metric.
Whole Foods has very tight and stable gross margins. The range is 1.8% over the last 10 years. Will Whole Foods be able to pass along costs? Yes. So if inflation is 3%/year, which is where the CPI has historically shown it, then we can add that to our growth rate. A 3% increase in costs seems to translate into 3% increase in profits. 9% new stores + 2% new traffic + 3% price increases gets me to 14% growth rate per year without having to break a sweat.
A Good Culture Leads to Strong Results
Companies that take care of their people have people that take care of them. Whole Foods believes in paying for quality. They do so in paying their workers more than Wal-Mart. In turn, their workers provide a much more pleasant experience for the customers that are willing to pay more for their products. This isn't hippie Marxist stuff. This is just good business.
Another point to make about the culture is that it is very difficult to pinpoint the politics of the company. In many businesses, you can tell which side of the isle the company is on. Whole Foods takes stances that are on both sides of the political spectrum. I'm not saying they stay neutral. They do take stances, but they are not consistently on one side or the other.
Whole Foods CEO has taken the following stances:
- Against Income Inequality
- Business isn't all about the profit motive
- Business is the greatest value creator in the history of man
Take a look at this interview and see for yourself.
Having a culture that sees many different ideas and doesn't just side with one political ideal is one that will be open to many new and innovative ideas. This fosters a long-term strategy of growth and sustainability.
Valuation is in the Mid $50′s
I see Whole Foods as a long-term growth story. I also see it as a very stable business model. The customers are loyal to the company. That means that in tough times, the company should be able to have minimal downside. People still have to eat and Whole Foods customers are not ones to compromise health to save a couple bucks.
At the current Free Cash Flow of $858M, 14% growth from above and an 8% discount rate, I get a fair value of $54.90. I used 8% because of their clean balance sheet and the fierce customer loyalty that makes their business much more predictable. The more predictable the fundamentals, the lower the discount rate I use.
I see Whole Foods as a great long-term investment. This is a situation where the stock price got ahead of itself and corrected. Whole Foods is one company you should keep on your radar to buy when Mr. Market panics.
And Mr. Market seems to be doing just that.
Disclosure: Author is long WFM.