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Whole Foods Market is a BMW. Stop Comparing it to a KIA

June 16, 2014 | About:

Whole Foods Market (WFM) is a “Buffett and Munger” cheap stock.

Put another way, it’s not really cheap.

It’s fairly priced but has the power to compound for years to come.

But if Whole Foods is so great, why is it selling near it’s 52 week low price?

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Fear Mongering News

Newspapers use fear mongering methods and click bait headlines to get clicks and views.

Institutions are jittery and nervous folks and you can tell these big players don’t know what they hold.

Fingers are always hovering over the sell button in case any “bad” news breaks.

Doesn’t matter whether it’s right or wrong.

Buying and Selling Stocks...

Buying and Selling Stocks…

The fear surrounding Whole Foods all comes down to competition from Wal-Mart and copycats driving margins down.

Let me show you why that’s absurd and why the 52 week low price isn’t cheap, but still a handsome gift.

Competition from Wal-Mart is No Competition

Here’s a quote from Walter Robb, co-CEO of Whole Foods, and what he told CNBC.

“Their customer [Wal-Mart] overlaps least with us,” he said.

Robb also pointed out that despite his company’s reputation for high prices, the Wild Oats assortment is dry groceries and Whole Foods has its private-label 365 dry grocery line, which “is also very price competitive.” It’s a validation, he said, “the market is growing overall.”

Whole Foods and Wal-Mart Customer Overlap to Worry About??

Comparing and worrying about Wal-Mart is like BMW comparing itself to a Kia.

Just because both brands offer cup holders, it doesn’t mean they are the same car.

The customer demographic of Whole Foods and Wal-Mart is entirely different. Just because Kia wants to enter the luxury market, it doesn’t mean BMW has to jump out of his seat and alter his pricing strategy.

While 20 percent of Wal-Mart shoppers are on food stamps, that shouldn’t be an excuse for subpar sales performance. Why? It’s because 22.3 percent of its customers have an annual household income of $50,000-$74,999, and 11.1 percent of its shoppers have an annual household income of $75,000-$99,999. – source

A quarter of Wal-Mart customers reportedly do not use debit or credit cards or even have a bank account.

Whole Foods customers?

Whole Foods Customer Demographic

Whole Foods Customer Demographic

Whole Foods customers don’t focus on price. They like what Whole Foods stands for and the way they conduct business.

Wal-Mart has the buying power to strangle and bully suppliers into coughing up cheaper prices. They also squeeze wages as much as possible to bring prices down.

Whole Foods goes about it completely the opposite way.

Products are locally sourced, and every product must satisfy rigorous ingredient and quality inspections that is stricter than the FDA.

Whole Food buyers also control a much smaller region which makes stores feel very local and community supportive. Much different to the way big Wal-Mart buyers operate and source for products. They want mass producers.

Getting certified organic farmers capable of mass production and distribution will take years to cultivate.

Mass producing organic food, trying to drive down prices, pricing out the local family farmers and consumers not knowing where the ingredients are coming from go against the whole image of “organic”.

These are risks that Wal-Mart is bringing on themselves.

BMW Can Easily Go Down Market, but Kia Can’t Go Up Market

Whole Foods isn’t worried about Wal-Mart. But Wal-Mart should definitely be worried about their own plans and how it can backfire.

BMW easily sells it’s 7 series for $100k and they can take advantage of their brand and luxury image to sell $30k cars to the masses.

Kia may sell a lot of $30k cars but can’t sell any $100k cars.

If Wal-Mart trains its customers to seek higher quality food, guess where they will be going sooner or later?

Yup.

Whole Foods, Trader Joes or Sprouts.

If you’re used to getting food from Whole Foods? Wal-Mart is off limits.

Check out the products that Wal-Mart sells that would never make it to Whole Foods shelves and savvy consumers know this.

And that’s where the whole idea of Whole Foods reducing margins due to competitive pressure is wrong. Whole Foods will decrease margins, not because of competition, but to penetrate competitor territory by offering more value brands like their 365 value offerings.

Also, Whole Foods has demographic requirements that it must meet to open a new store.

But to achieve the growth of 1,200 stores in the US within the decade, they have to relax the criteria to enter more accessible markets.

By going smaller in markets such as Brooklyn and Boise, and bigger in previously unimaginable urban areas, such as Downtown Detroit and Englewood, a gritty Chicago neighborhood, Whole Foods is delivering on its bigger promise of becoming accessible to the masses – source

A Proper Comparison to Whole Foods Market

Costco and Starbucks are similar companies to Whole Foods.

What?

The culture, brand loyalty and following of these companies are very similar.

Costco members love the deals and the adventure of shopping there. There are other warehouse competitors, but Costco customers are extremely sticky.

Then there is Starbucks.

Coffee is a commodity but they’ve somehow made it into a status symbol. McDonald’s, Dunkin Donuts and Keurig machines were supposed to have damaged Starbucks’ business, but it’s thriving.

And the reason is that the brand goes beyond just coffee and doesn’t compete on price. They sell the experience, the status and the community.

Even with copycats like The Fresh Market (TFM) and Sprouts Famers Market (SFM), the industry is big enough to accommodate them all at the moment. In fact, the industry size should expand as people become more conscious about what they eat.

So What’s the Valuation?

Whole Foods is surprisingly easy to value because the company is very transparent with their plans and numbers.

With the info you are provided, you can calculate the growth and maintenance capex very easily. When necessary, I use Bruce Greenwald’s teaching to calculate maintenance capex. By splitting growth and maintenance capex, you can get a more accurate owner earnings number to use when valuing stocks with a Discounted Cash Flow.

Here are the important stats.

Calculating Growth and Maintenance Capex

  • Last year they opened 32 new stores
  • Total capex was $537m
  • $339m was growth capex used for new store openings

So the average cost to build each store is $10.5m. New store opening target for this year is between 33 to 38.

Multiply 10.5m by 33 to 38 and you get a growth capex range of $350m to $370m.

Now Whole Foods expects the total 2014 capex to be around $600m – $650m. To keep things conservative, I’ll use the $650m number.

So the maintenance capex is going to be around $280m to $300m.

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Discounted Cash Flow Valuation

Putting it all together, my inputs to a DCF will be

  • 9% discount rate (how I choose discount rates)
  • using a growth range from 9% to 13% which includes a decay rate
  • starting FCF of $800m (8% growth in cash from operating activities minus $300m maintenance capex)

My intrinsic value range is between

Then using growth rates ranging from 9% to 13%, my DCF intrinsic value range is $38 to $48.

Whole Foods DCF Valuation

Whole Foods DCF Valuation

Whole Foods DCF Sensitivity Matrix

Whole Foods DCF Sensitivity Matrix | Click to Enlarge

At the moment, it’s fairly valued, but great companies rarely go on big sales.

EBIT Multiple Valuation

But if you don’t like DCF’s, here another angle to look at.

Let’s do an EBIT valuation to value the stock based on the income statement and balance sheet.

I’ve got an online EBIT calculator you can play with, but I’m using my OSV fundamental stock analyzerin this case to quickly do everything for me. Here’s a short tutorial video explaining how it’s done.

Whole Foods EBIT Multiple Valuation

Whole Foods EBIT Multiple Valuation | Click to Enlarge

The intrinsic value ranges from a conservative scenario of $34 all the way up to $60 with aggressive assumptions.

The base case valuation is $45. Very much in line with the DCF.

A Wonderful Company at a Fair Price

Like I said at the beginning, Whole Foods isn’t cheap, but it is Buffett and Munger cheap.

far better to buy a wonderful company at a fair price

Far better to buy a wonderful company at a fair price

I’m more than happy to hold Whole Foods at these prices and let compounding do its work.

Management have proven themselves to be great allocators of capital and there are intangible benefits within the community that will only strengthen their brand going forward.

Here are some extra valuation multiples to give you a clearer picture.

Whole Foods Valuation Multiples

Whole Foods Valuation Multiples | Click to Enlarge

Summing Up

Don’t worry about Wal-Mart. A Kia can’t compete with a BMW.

Whole Foods is a company that I will comfortably hold for many years and watch it compound as the industry expands and management continues to meet goals.

Good References and Resources

Disclosure

Long WFM

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


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