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Whole Foods CC Acrimony



May 12, 2014 – Comments (1)

Board: Value Hounds

Author: MonsterFluff

What a nasty conference call. Where is all the analyst-love for Whole Foods? They used to be so nice. They now attack like Whole Foods is a wife whom they just found out is having an affair behind their collective backs. Such bitterness and acrimony!

Here is one uncomfortable exchange:

Ken Goldman - J.P. Morgan

Thanks. I have to admit, I’m surprised by what I perceive to be a constructive tone on this call. You’re telling us that our estimates for the next couple years are significantly too high. Your stock’s down around 14% after hours. One of the questions I’ve been getting lately is does Whole Foods management appreciate that the world has changed and there’s a lot more competition out there?

I’ve got to be honest. I’m not really hearing anything that’s suggesting management is taking this situation as seriously as some investors want you to. There’s a lot of talk about what’s going, not a lot to talk about what it takes to win the change market. I’m really just curious what are you doing differently versus a year ago other than taking your cost down which I think the market’s telling you may not be enough anymore?

Harsh J.P. Morgan dude. But John Mackey’s reply was a little weak--could've been better:

John Mackey - Co-Chief Executive Officer

Well, we’re lowering prices. We’re making investments on price. We’re cutting expenses. And we’re…

And then J.P. Morgan dude interrupts.

Ken Goldman - J.P. Morgan

You’ve been doing that for years. You’ve been taking price down for years. I mean, it’s hard to understand.

Well OK —score one for Ken. WFM has been trying to deal with price image for a few years. From March 2012 two years ago

We have worked very hard over the last couple of years to successfully improve our price image, particularly in perishables, and we are focused on improving our relative price positioning in the marketplace. We are hopeful we can continue to strike the right balance between rising product costs and our retail pricing based on our contracts, distribution, and tools to manage value.

Gross margins show little evidence of cost cutting.

Mackey unfortunately then gets a little defensive, back tracks and tries to justify the numbers. Obviously, WFM has not had to cut prices at the cost of sales much even though they were introducing a lower price for selected products –gross margins are rising

John Mackey - Co-Chief Executive Officer

No, we haven’t. I mean, if you look at we had rising gross margins for the last five years. So we haven’t been investing in price as aggressively as we probably needed to do. So we’re going to be investing more aggressively in price going forward while continuing to take our expenses down and continuing to innovate and differentiate. That’s our strategy. We’ve laid it out. So there you have it.

It’s a cringe-worthy exchange. Analysts are not cutting Whole Foods any slack this quarter.

Is it really that bad?

It does seem like everyone is opening a chain of organic grocers these days. There were a couple of high profile IPO’s that are making the space/niche look a lot more crowded.

Sprouts IPO was August 2013 and it more than doubled day one. They have 167 stores and growth has been through a couple of large acquisitions. Sprouts isn’t new—around since 2002. They are now in 8 states mostly Colorado, Arizona and California. The states are contiguous in the southwest mainly. They target 1200 locations.

Whole Foods has a perhaps too-heavy presence on the coasts including California but otherwise don’t have many stores in the Sprouts stomping grounds. Competition? Not much from SFM at least by geography.

Sprouts subliminally bills itself as the poor man’s Whole Foods and concentrates on bargain pricing to drive traffic and be competitive.

Natural Grocers is the other recent high profile IPO. They came to market July 2012 and also ran up fast. The IPO was $25/share and hit a high of $45 this year. Sprouts hit its high just shortly after the IPO in November ($48). Parenthetically, both have corrected mightily – NGVC is $24 and SFM at $26. Sprouts quarterly results were good and NGVC disappointed and was crushed.

NGVC has 76 stores in 13 states and heads north into Washington, Oregon and Montana. They have no presence to speak of in CA. They do overlap WFM and SFM in AZ, CO NM, and TX.

Both Sprouts and Natural Grocers have stores in Whole Foods states but don’t overlap much on the dense east coast and midwest. It’s probably not as much about what seems like a lot of new competition from high profile IPOs but more likely from privately held local stores and the big box boys like Walmart and Kroger’s and Safeway incurring on Whole Foods traditional turf. That’s going to be a hard slog for Whole Foods who really can’t play the discount game.

And that was the heart of the nasty exchange with J.P. Morgan. With disappointing results from Sprouts and Natural Grocers, it may be the competition is from traditional grocers with a heavy presence across the US and all are going to feel the pain.

…..specialized stores such as Whole Foods and its peers accounted for just 44 per cent of 2012 organic sales, versus 46 per cent at mass-market retailers including traditional supermarkets, discount chains and warehouse clubs.

Last month, Walmart, the world’s largest retailer, announced plans to sell organic foods at cheaper prices in an attempt to capture more of the US organic market

What set the selling off?

The sell off was less about the Q2 results which were good, (not great) but more about where Whole Food is going in the next few quarters. Did guidance warrant a 20% drop? We'll talk about guidance and it wasn't all doom but not completely rainbows either. Even-handed is a fair description. I still like Mackey in spite of the uncomfortable moments on the conference call. He's a realist.


The quarter was mostly about competition, slowing growth, the need for value priced product, and the threat of margin contraction. The second quarter was actually good and standalone would not have instigated a panicky sell-off.

Competition may not be a new threat and maybe such things go through cycles, but the field of contenders has broadened and intensified as even traditional big box grocers try to find higher margin product and “not so organics” like the Fresh Market try to look wholesome and sneak into WFM territory. It’s shark-infested waters for Whole Foods trying to defend its ethical and guaranteed organic space.

Walter Robb - Co-Chief Executive Officer

I think it’s important to understand that competition has accelerated. There’s no question about it. We’ve seen the conventional supermarket companies like Kroger and Wegmans and HEB, they certainly have upped their game in natural and organic foods. We’ve seen new entrants get public money such as Sprouts, Fresh Market, Natural Grocer, they’re expanding more rapidly. Trader Joe’s continues to expand.

So I’d say competition is more intense right now than possibly we’ve ever experienced before. But it’s also important to understand the Whole Foods Market is still gaining share. I mean, we’re still growing our comps at a much faster rate than the rate of inflation.

So we’re just not gaining it as fast as we have gained it in previous years. So we still remain the leader in this category by I think a pretty significant margin. And we think the markets continue to expand as well which is why all these guys are jumping into it. They see there’s a change, that natural and organic foods are continuing to penetrate to a larger marketplace and everybody wants in on it. So I think for a long time Whole Foods had the field to ourselves, pretty much. That was nice.

But we don’t any longer. So we’re adapting to the reality of the marketplace which is increased competition and important that we continue to innovate, differentiate, while paying more attention to value. That’s why we’ve outlined sort of how we see ourselves moving forward over the next five years. We’re obviously radically increasing our store growth. We have never opened stores at this type of pace before.


Revenue growth is definitely slowing even as the pace of stores opening picks up. One more number I track is the growth in comps + stores compared to revenue. I think if it far exceeds the revenue growth we are getting a lot of new stores that are taking time to ramp up production to average weekly sales.

It takes some time for new stores to get up to speed.

For the last eight quarters new stores class averaged sales of $503,000 per week compared to $729,000 in total average weekly sales. It’s easy to see that the more stores you open, the faster that store growth is compared to your growth in revenue—right? So analysts were asking about the strategy of more numerous store openings with slowing revenue growth. They have a point. The new stores have sales per square foot of $729 compared to $1000 for the entire base. New store productivity levels are 86% and contribution margin is 4%. However, with AWS continuing to increase, the new stores do get up to speed (maybe it's taking longer)and don’t drag on the base. Until we see AWS begins to decline, the rate of new store openings seems sound especially given there are wide swathes of the country where Whole Food either has no presence or a very small number of stores. The target of 1200 doesn’t look untenable.

Revenue increased $300 million to a record $3.3 billion with comparable store sales of 4.5%. Traffic only slightly exceeded basket price at 2.4% to 2.1%. The company has usually managed 60% of a comp in traffic and 40% for price.Higher traffic is good. There has been no quarter in the past year that WFM managed these percentages. This has implications since price is coming down on enough product to drop gross margins. If traffic doesn’t improve, the pricing is going to destroy same store sales. We will definitely need to check comps and traffic over the next few quarters—I’m sure the market will.

Tracking the growth of revenue against the comps+store growth shows a bigger gap in 2013/2014 than in previous years. What that says (at least to me) is that new stores are opening fast but taking a longer time to reach average weekly sales (AWS). This is an inexact number not accounting for timing of openings but it does suggest a trend. Adding more stores is not necessarily growing revenue as efficiently now as it has in the past.

As we continue our value strategy to broaden our appeal and drive sales growth over the longer term, we expect our gross margin to return to our historical range of 34% to 35% over the next several years.

Current margins are significantly higher and this is going to be painful in the short-term unless and until WFM can bring in more traffic making up lost pricing power with heavier volume—the Walmart strategy.

Whole Foods is still one amazing business with several metrics improving that leave competitors in the dust.

With new store additions they increased operating square footage 8% to $14.2 million and 374 stores across 41 states & in three countries. Average weekly sales per store are $743,000 and sales per square foot are an awe-inspiring $1,000. These measures improve nearly every year and every quarter. Sprouts and Natural Grocers don’t live in the same neighborhood as these numbers. NGVC is close at $729/SF. Sprouts was around $450/SF. Margins for both are considerably lower.

Going first to the comps+store growth metric and stacking it up against revenue growth we immediately see that until 2013, it tracked revenue growth closely. Again this seems to suggest the pace of store growth directly and quickly adds revenue as stores are opened. There is no lag. That changed in 2013-2014. Sometimes that indicates cannibalization or failure to take market share in the neighborhood. Also notable is slowing revenue growth from low teens to single digit in the most recent three quarters partially explaining the sinking share price.

A positive for WFM are annual weekly sales continuing to increase even as they add stores. While Whole Foods has seen some problems with cannibalization in comps, its market share has increased enough to offset the lost dollars in areas where it has a heavy number of stores. While one store loses a little to a new sotre, the others make up for it by poaching customers from other organic grocers.

Pull up a map of Whole Foods stores and it’s obvious they have a dense presence on the coasts and not much in between.

Cannibalization comes through overbuilding in a limited geographic area. New stores siphon off revenue from older stores or the other way around—new stores fail to gain
traction and perform up to older stores historical standards.

If cannibalization starts to result in lower average weekly sales then there is a problem -- too many stores, failure to take market share, stealing from each other with revenue spread over an inefficient base. Whole Foods is not there yet.

Whole Foods is in the process of opening seven acquired Dominick’s store in Chicago and will have them up and running in 2015. That makes 28 stores in the Chicago area. There is a question of cannibalization with the dense presence and this is typical of their growth strategy on the coasts with a much thinner base in the Midwest and southwest. They think cannibalization will be minimal and Chicago can support all the locations. It illustrates just how many stores Whole Foods can have in one geography and do well far outstripping Sprouts and Natural Grocers presence.


Food is a commodity and competition is cutthroat. Whole Foods has made an extraordinary niche for itself as food with integrity and customers haven’t flinched at paying for that. The company is beginning to feel the pressure of competition now as they haven’t at any other time in their 36 years. The conference call was heavily laced with questions and comments about the strategy for surviving. Part of that is the 21,000 skus, local produce, high quality in-store restaurants and premium proprietary brands.

John Mackey

Whole Foods Market does not want to engage and as you say, we don’t want it to become a commodity where we’re trying to just compete on the basis of price. That’s not what we want to do. Instead, we are upping our game in terms of differentiation, innovation, service, quality and overall experience that we give to our customers. You can see this if you go into many of our new stores. And we’re opening, I mean, we have 114 stores we’ve announced and we’re finding more and we just approved a bunch more stores today before this meeting.

So, we’re rapidly increasing our growth and we’re opening tremendously good stores that we think will set us apart from our competitors and we are a very-very creative, innovative company. So at the same time, we have to recognize that we have more competition going after us, kind of, on the margins on certain well-known brands and products and we can’t ignore that. We have to meet that challenge head-on and we are doing that.


The value strategy to bring back customers and drive sales growth over the longer term is going to crunch gross margins. The key will be to get traffic back to 60% of comps and maybe even slightly more as price or market basket is going to decrease as Whole Foods drops prices. In this sense they are going with a lower margin higher volume business strategy and it’s not clear it will work. Over the next few quarters looking for increasing traffic and seeing it succeed will tell us if the strategy is paying off. It’s an easy thing to follow. Gross margins are going to revert to the historical range of 34% to 35% after hitting records around 36% this quarter. Operating expenses should continue to decrease helping operating and net margins.

They have reduced operating expenses by 175 basis points over the last five years and will be working continuously on the cost structure to offset the impact of declining gross due to a value-oriented strategy.

Whole Foods is projecting sales will grow by $11 billion over the next 5 years bringing 2020 revenue to $25 billion –about double 2013 revenue. They will be doing the growing through an increased number of new store openings-- 56 new leases signed over the last 12 months and a record 114 stores in the development pipeline.

In 2014 they will reach 400 stores and cross the 500 store mark in 2017. Over the longer term, the target is 1,200 stores in the United States alone.

What to watch

Guidance is impressive predicting a doubling in revenue in the next 5 years and improved operating margins through trimming expenses. With only 379 global stores now, Whole Foods is not even close to its targeted 1200 US stores. The nagging question is can Whole Foods make 1200 stores work profitably or is competition going to kill their plans for growth. Fortunately there are a few things we can check as Mackey and company prepare to engage the competition.

Look for traffic to make up the biggest percentage of comps. It tells us that value pricing is in fact working to bring customers in and consummating purchases.

Average weekly sales need to keep growing. If they start to drop, either Whole Foods is stealing sales from itself through cannibalization and/or is not gaining market share from ever-increasing competition.

Revenue growth and comp plus store growth don’t diverge widely.

Revenue margins may revert to 34%-35%, but we would like to see operating margins and net at least stay at current levels and at best expand.

Revenue growth returns to low teens.

With more than half its projected growth ahead, Whole Foods has time to pull out of its slump and continue to dominate the organic niche. Do they have the vision and the resources? Mackey has guided the business from “hippies selling to hippies” to a $12 billion powerhouse. My guess is he’s up to the challenge.

More of the best of WFM

No term debt or credit facilities. Whole Foods paid off the nearly billion dollars they took on to buy Wild Oats. Impressive

$1.2 billion in cash

Forward dividend 48¢ per share and yield of 1.2%

Cash flow positive and that cash flow easily pays for new stores. Capital structure is impeccable.

By WFM’s calculations, ROIC sans capitalized leases tend to run in the low to mid teens exceeding the cost of equity by several percent. I put WACC or cost of equity at around 9%-10%.

Whole Foods is a great business—solid and ethical. It deserves to succeed. It is extraordinarily well run, has some of the most beautiful SEC filings in the world, and is less than half way to the ultimate store base. As a shareholder I’m betting on Mackey.


1 Comments – Post Your Own

#1) On May 12, 2014 at 12:02 PM, rofgile (99.46) wrote:

Thanks for the repost.  This had a lot of info, maybe a bit too much and not quite organized but, still some good notes.


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