By: Justin Hellman
It's been a challenging year for Whole Foods Market (WFM), with its large-cap shares declining over 15% thus far in 2014. The main problem has been a deceleration in same-store sales growth, resulting, we think, from stepped-up competition, particularly from value-oriented grocery chains and mass merchandisers. Indeed, comps are now running well below the company's long-standing 6% target. This has offset expense reductions and share-net benefits from stock buybacks. Moreover, the comp slowdown has spooked many on Wall Street, and led to a contraction in the issue's P/E multiple. Business showed signs of perking up during the fourth quarter of fiscal 2014 (ended September 28th), however, with earnings of $0.35 a share surpassing the consensus view by $0.03. And numerous traffic-boosting initiatives look promising, suggesting that a same-store sales turnaround may not be too far off. So what are investors to do now: build positions or steer clear of this high-profile name until visibility improves? In this brief article, we will attempt to address this key question by taking a look at Whole Foods' operations and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
Austin, Texas-based Whole Foods Market, founded in 1978 and public since 1992, is the leading retailer of natural and organic foods, and the nation's first "Certified Organic" grocer. The company has around 87,000 employees, and maintains a network of over 400 stores in the U.S., Canada, and the U.K., with units varying in size from 30,000 to 55,000 square feet. In addition, it generates more than $14 billion in annual sales, roughly two-thirds of which are from perishable items (e.g., fruit, vegetables, meat, seafood, cheese, etc.).
Best-of-Breed Company in an Attractive Industry Segment: Demand for organic food is rising at a much faster clip than the broader food industry, which is pretty mature by most measures. Indeed, the natural/organic segment has been expanding by 7%-10% a year, compared with only about 1%-3% for the traditional food sector. This has enabled Whole Foods to expand aggressively since going public, and to grow its top and bottom lines at double-digit clips over the past decade -- a feat not matched by most of its top competitors, including The Kroger Company (NYSE:KR), the largest grocery store operator in the country. And we see the relative strength persisting well into the future, notwithstanding pricing pressures and the recent downshift in comps. Whole Foods, importantly, led by Co-CEOs John Mackey and Walter Robb, has an enviable track record of consistent, excellent execution. What's more, apart from several company-specific initiatives that promise to put a charge back into same-store sales, results should head north as the "foodie" population swells (a "foodie" is anyone who has a passionate interest in food and drink), and as the public's enthusiasm for natural/organic products continues to build.
Strong Free Cash Flow: Whole Foods generates a lot of cash, even after accounting unit remodels and spending on other sales initiatives. What's more, it generally looks to return a good portion of this liquidity to shareholders, split about evenly between dividends and stock buybacks. (Based on the new quarterly payout rate of $0.13 a share, the yield is a little over 1%.) This seems to make sense, since cash and investment balances are garnering very modest returns at present. Thus, we expect repurchases to be accretive to share net in the years ahead, and think that the dividend will approximate at least $1.00 a share on an annualized basis by the 2017-2019 time frame.
Premium Pricing: Whole Foods, like Starbucks (NASDAQ:SBUX) in coffee and Tiffany & Co. (NYSE:TIF) in the jewelry space, is a higher-end retailer, predominantly targeting middle and upper-income consumers. (Customers have a median income of more than $75,000.) This positioning has historically served it well, with the company's margins consistently outpacing the industry average. But the luxury orientation can also be something of a detriment, as it renders the grocer vulnerable to budget chains that have more defensive businesses and offer a better price/value proposition. And same-store sales could well lose more steam if the economic expansion in the U.S. is derailed by the slowdowns being seen overseas, in China and throughout the euro zone. Whole Foods did struggle during the 2007-2009 recession that took a heavy toll on blue and white collar workers alike. In fact, its stock sank below $4 at one point, before staging a powerful, multiyear recovery.
Traffic-Boosting Measures: Comp trends have begun to improve lately, as Whole Foods has endeavored to shore up its competitive position by strategically cutting prices and stepping up its advertising/branding efforts. The company, notably, just launched its first national TV ad campaign that aims to emphasize the concept's commitment to food quality, public health, and environmental sustainability, and that is generating a lot of excitement in the employee ranks. And pricing tests are going well so far, with cuts already making a difference in terms of unit sales. These factors, along with a new affinity/customer loyalty initiative, an expanded wine program, an enhanced digital presence, and greater investments in the store base (e.g., major interior/exterior remodels), suggest that a meaningful acceleration in comp growth may be in the cards in fiscal 2015. That said, a return to the 6% same-store sales target level will probably be difficult to achieve, given the new competitive landscape that management is now navigating.
Tighter Cost Controls: Planned price cuts are apt to weigh on margins, but Whole Foods should be able to offset the pressure, at least partially, by streamlining its overhead structure. In particular, the company, which has been executing exceptionally well from a cost and capital allocation standpoint since the last recession, should be able to make more of its scale advantages and boost efficiencies in the key areas of distribution, labor, and procurement. A planned consolidation of all point-of-sale systems will likely be good for profits, too, and improve the overall customer experience.
Overseas Exposure: While it maintains a small cluster of stores in the U.K., Whole Foods is far from an international operator. This will probably change over time, however, with an attempt to leverage the upscale brand in continental Europe apt to materialize before too long. Such a push abroad would likely add many new chapters to the company's unique growth story.
Aggressive Rivals: Conventional supermarket chains, not to mention mass merchants (e.g., Wal-Mart Stores (NYSE:WMT)) and local mom-and-pop grocers, are increasingly stocking organic and natural food items in an attempt to jumpstart their top lines in what is a fairly mature industry. This could force Whole Foods to reduce prices further in the coming quarters, which would likely squeeze gross margins and profits.
Cannibalization: Same-store sales have been hampered in certain territories, such as Boston, where the company has two or more units in close proximity to each other. This could become more of a problem going forward, as Whole Foods tries to take the domestic unit base from 400-plus to 1,000 and beyond. Consequently, though opportunities to extend the (underpenetrated) brand appear plentiful, we would expect square footage growth to slow down a little as we approach late decade. This is already happening to a limited degree, with the company looking to bolster returns and margins by opening smaller units in select markets. Of note, the average Whole Foods location is about 38,000 square feet in size today, down from closer to 58,000 square feet back in 2008. That said, the company still forecasts a square footage increase of 10% in fiscal 2015, which would be rather impressive, in our view. And annual store growth in the high single-digits appears achievable over the long haul.
Although competition is intense and same-store sales trends have not lived up to historical norms lately, we believe that Whole Foods' strengths and opportunities currently outstrip its weaknesses and threats. For more information, please check our full-page report in the Value Line Investment Survey.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.