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Is Whole Foods the next Starbucks?
Whole Foods coaxes consumers into paying more for health-oriented groceries with elaborate 'lifestyle' stores. Sales have soared. So has the stock price.
By Robert Walberg
Some stocks seem capable of defying the basic principles of physics in that they go up but rarely, if ever, come down. One such stock is Whole Foods Market (WFMI, news, msgs), the country's leading natural and organic foods supermarket. Playing to the nation's growing desire for a healthier lifestyle, Whole Foods' stock is up by a very unnatural 1,522% over the past decade.
What's most amazing about this story is that Whole Foods has enjoyed such success operating in the traditionally low-margin, cutthroat retail grocery industry. This is a business where operating margins are thinner than a slice of prosciutto.
But just as Starbucks (SBUX, news, msgs) managed to get consumers to pay outrageous amounts for a cup of coffee by creating a lifestyle company, Whole Foods gets its costumers to pay higher prices for its goods by appealing to a desire for healthy, natural products in an attractive setting operated by courteous, helpful employees.
Also just as with Starbucks, there are times when the stock hits such lofty levels that it's best to keep your distance until some event pushes it down a bit. This is one of those times.
A true experience
With fewer than 170 Whole Foods stores across the country, many of you have probably never set foot in the place. That's too bad, because entering a Whole Foods store is a delight to the senses. The produce section explodes with color; there are as many as six different peppers to choose from, four different types of pears, fresh berries of all kinds and enough lettuce to appease a small army of rabbits.
The fresh meats section brings me back to the time when I lived in Brooklyn, N.Y., and used to shop at the local butcher store. Steaks are thick, red and beautifully displayed. Meanwhile, there's more fresh fish than you see at any of the grocery store chains -- everything from tilapia to monkfish. And for those of us who're single or simply too busy to cook, Whole Foods has a variety of prepared options such as kabobs, chicken stuffed with cheese and pine nuts, crab cakes, marinated steaks, etc.
Then there's the deli, or prepared foods, section, with pastas, twice-baked potatoes, salads, lunch meats, soups and even sushi. This isn't fast food, but one of the most tempting collections of good, healthy, ready-to-serve food that you'll find anywhere.
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Naturally, the basic grocery items like juices, cereals, pastas, frozen foods, etc. are carefully selected and don't mirror what you typically find in a Jewel, Albertson's (ABS, news, msgs), Pathmark Stores (PTMK, news, msgs) or Safeway (SWY, news, msgs) store. Again, the focus is on natural, healthy products.
Customers happily pay more
Of course, my favorite is the wine-and-cheese section, a little slice of heaven on earth. There are dozens of different cheeses and wines from around the world, and all at surprisingly reasonable prices.
Make no mistake, consumers pay more for the Whole Foods experience. But nobody shopping there seems to mind one bit. In fact, whenever I shop there the stores are crowded. Additionally, the company's internal data suggests that consumers spend more time in its stores than in traditional supermarkets because of the unique variety of products.
Considering how much American consumers spend on diet and cosmetic products, it comes as no surprise that a retailer focusing on healthier lifestyle choices would be a success. And there's no other way to describe Whole Foods than as a huge success.
With so few stores across the country, the success story is likely to continue for years to come. Last quarter alone, the company signed seven new leases, bringing the current pipeline of stores to a record 59. According to a recent article in The Wall Street Journal, a Whole Foods store in the neighborhood actually increases property values, a selling point I'm sure the company will exploit to the fullest when it negotiates future leases.
However, if there's a risk to the new store openings, it's that the company is expanding the average size of its stores. The average store size of the seven leases signed last quarter was just over 50,000 square feet. So far, the larger stores have met with success, with same-store sales comparisons actually besting the growth rate of smaller stores (though store ages tend to skew the comparisons in the favor of the larger units). Nevertheless, the large-store format is relatively new, and how it'll play across the country -- and how it'll affect profit margins -- is still largely unknown.
A short-term damper
The costs associated with the store openings is also apt to put a short-term damper on earnings growth, though investors might view such expenses as a necessary evil given that expansion is needed to sustain the type of heady double-digit growth Wall Street has come to expect.
These might seem like small concerns, but with the stock trading at 46 times estimated fiscal 2005 earnings of $2.42 and 1.7 times trailing 12-month sales, even the smallest miscue could lead to a meaningful retreat in the stock price. Traders should also note that the stock sports an enterprise value-to-sales ratio of 1.7 to 1, which is not only high for the company, but well above the industry average of 0.3 to 1.
Clearly, Whole Foods deserves its premium multiples to the market and to its industry. It's growing sales at nearly 20% annually, or more than twice the rate of its closest competitor; has little to no debt (an anomaly in the grocery industry); boasts an impressive return on equity of 13.4%; and generates millions of dollars in free cash flow.
Still, while Whole Foods is a wonderful company and a great shopping experience, the stock is trading at all-time highs and the valuations are at the high end of historic ranges, which means the stock isn't a good buy now. Investors would be better served to step out of the checkout line and wait for a pullback of at least 10% to 15% before buying.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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