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The Organic Niche Holds Great Growth Prospects for this Grocery Retailer

March 13, 2014 | About:
Patricio Kehoe

Patricio Kehoe

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Whole Foods Market Inc. (WFM) began its operations in 1980 and has since grown to become the world’s leading retailer of natural and organic foods. It is also the first Certified Organic Grocer in the U.S. The company has a strong brand image and its banner is a synonym of quality and health. The firm offers a wide range of organic products, including those of its private labels, through a network of 373 stores mostly located in the U.S., but also in Canada and the UK. Moreover, the company owns and operates 10 regional distribution centers and four seafood processing and distribution facilities.

An Intangible Asset

Whole Foods’s leading position in the $80 billion domestic market is the result of a strong brand image that has earned the firm a narrow economic moat. This intangible asset has enabled the company to sell its products at premium price points and also to attain above-average sales per square foot, thus achieving excess returns on invested capital. Furthermore, it favors a higher private-label penetration, thereby strengthening customers’ loyalty while boosting margins.

Rivalry

Although switching costs are almost nonexistent in the grocery industry, Whole Foods has developed a solid competitive position through a differentiated value proposition that comprises a vast array of products offering and distinct customer service. These traits and its large network of stores have kept the firm ahead of notable competitors like The Fresh Market Inc. (TFM) and Sprouts Farmers Market Inc. (SFM). These rivals operate roughly 150 stores each and handle an average of 10,000 stock- keeping units against 20,000 at Whole Foods.

Sourcing

In order to maximize volume discount, Whole Foods purchases at regional or national scales. While many of its perishable products are obtained from local producers, almost a third of the company’s purchases are sourced from United Natural Foods Inc. (UNFI). Their distribution agreement, valid through 2020, stipulates that UNFI will be the company’s main provider of frozen foods and groceries. However, the company seeks to diversify its supplier base by sourcing form local farmers who are eager to suit its high-quality food production standards.

Growth Drivers

The company’s successful mix of effective inventory management and strict cost-control measures adds to a revamp of its pricing strategy and a greater focus on value offerings. Hence, Whole Foods has delivered healthy gross margins in the range of 34.8% to 35.5% over the last three years.

Furthermore, the company continues to open new stores and to integrate regional acquisitions. It opened 32 new locations in 2013 and expects to reach the count of 500 by 2017. As store volume augments, the firm benefits from both lower per unit costs and sales increases. Its comps, in turn, also help bolster margins, since they continue to follow an upward trend. Moving forward, Whole Foods expects an escalation of 11% to 12% in total sales for 2014.

Sturdy Growth Profile

Whole Foods’ strong brand image, high-quality products and marketing expertise have earned the firm one of the strongest growth profiles in the industry. Its stock trades at 35.80 its trailing earnings, a premium compared to its peers’ average of 19.10. Its earnings per share growth, however, showcases an impressive 27.20% against the industry median of 5.10%, which will lead to more attractive multiples. Further, the stock delivered a healthy return on equity of 14.20% compared to its rivals’ 9.80% average and its return on capital an outstanding 36.40% against its peers’ average of 19.70%. Investment guru Ray Dalio (Trades, Portfolio) recently incorporated Whole Foods to its portfolio, backing my bullish feeling about the firm’s exceptional growth potential.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

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