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In the last two decades, with the rise of warehouse discount clubs and megastores combining food and general merchandise, Americans have become accustomed to rock-bottom prices and all-in-one shopping. Little wonder the country's largest grocery chains have lost market share and seen revenues and earnings stagnate.
Here's an exception: so-called "natural" grocery stores. Whole Foods Market (WFMI
), the largest retailer in this growing sector, is among those bucking the trend as it attracts an affluent and health-conscious audience willing to pay up for organic food and other items. In the five years through the end of fiscal 2002 on Sept. 30, revenues doubled to $2.7 billion. Net income jumped 112% in the same period. And investors took note. Over the past two years, Whole Foods' shares rose about 75%, while other food retailers and wholesalers declined 24%.
Yet the tough economy seems to have dampened sales growth at Austin (Tex.)-based Whole Foods recently. Same-store sales increased 6.8% in its fiscal second quarter, ended Mar. 31 -- down from a 10% rise in the same period a year ago. Investors haven't taken the slower growth in stride. Since the start of 2003, Whole Foods shares have fallen 8%, to around $50, as of July 16, while food retailers and wholesalers as a group have declined just 2%. The broader market, of course, has fared much better. The benchmark Standard & Poor's 500-stock index is up about 10% in the same period.
THE REAL THING. Whole Foods has cautioned investors that year-over-year sales comparisons may be disappointing for the rest of fiscal 2003, ending Sept. 30. However, over the long term, analysts are optimistic that Whole Foods' financial performance and its stock will rise as consumers continue to follow their appetite for healthy food. If so, any further short-term decline could be an opportunity for buy-and-hold investors to step in.
Makers and retailers of natural foods have shown "pretty good evidence that they're a real industry," says Kenneth Duca, vice-president of Times Square Capital Management. Duca likes Whole Foods, but its market cap has grown too large for the firm's small-cap funds. (Times Square does own United Natural Foods [UNFI
], a maker of natural foods and a supplier to Whole Foods. Duca doesn't personally own stock in either company.)
Retail market consultancy Retail Forward estimates that the organic-food business is growing at about 10% a year compared to a puny 2.5% rate for traditional supermarkets. According to the Natural Food Merchandiser trade group, the business grew from $25 billion in 1998 to $34 billion last year.
EDGE OVER OATS. By the end of the decade, Whole Foods has forecast it could reach $10 billion in annual revenues and 300 stores nationwide. BB&T Capital analyst Andrew Wolf figures that revenues and earnings could rise around 20% annually for the next several years. "They're one of the real core growth stocks to hold in retailing," he says.
Wolf rates the stock a buy and expects it to gain 16%, to around $57, in 12 months. Whole Foods also may have an edge over its only direct competitor, Wild Oats Markets (OATS
), says Wolf. It had sales per square foot of $430 in 2002, while Whole Foods brought in about $700. (Wolf doesn't personally own the stock, and BB&T Capital doesn't do investment banking for the company.)
In the past 20 years, including the difficult ones of late, Whole Foods has managed to increase sales at stores open at least a year (same-store sales) by an average 8% annually, says Executive Vice-President for Operations Walter Robb. It will open 12 new stores in fiscal 2003, fewer than the expected 15. Robb says 2003 "is a one-year aberration." Whole Foods has projected 15 to 20 openings in 2004, he says. "We believe that we'll be producing higher growth in 2004 and going forward."
"LOW WATER MARK"? Also expected to drive growth next year are two of Whole Foods' largest stores to date, at more than 50,000 square feet each. The new stores in Manhattan's Union Square and Columbus Circle should be significant earners, predicts Robb, since outlets in the Big Apple's Chelsea neighborhood are among its five most-profitable, out of a total of 145 nationwide. Whole Foods also has a wide-open field of new geography to explore, since its stores are in only 30 of the country's top metropolitan areas.
Shares trade at a fiscal 2004 price-earnings ratio of 26. That's considerably higher than the average forward p-e ratio afforded supermarkets of about 14, but the potential for growth is also significantly better. While Whole Foods' same-store sales are increasing in the mid to high single digits, the same measure at traditional supermarkets like Albertsons (ABS
) and Safeway (SWY
) have been flat to negative. In its most recent quarter, Albertsons, which has 2,287 stores, reported a 0.9% decline in same-store sales.
According to Robb, the markets will "see that the second quarter was a low water mark for Whole Foods." Investors will be watching carefully for evidence that he's right in fiscal third-quarter results ended on June 30, which are due on July 30. On average, analysts expect earnings per share of 42 cents, up from 36 cents in the same quarter a year ago.
Looking ahead, Whole Foods will face more competition, as traditional supermarkets try to expand their organic and natural food offerings. And low-price retailers like Wal-Mart (WMT
) and Costco (COST
) may continue to lure customers away from supermarkets, including the likes of Whole Foods. Still, if Whole Foods can deliver the goods on its conservative forecasts -- as aging, health-conscious Baby Boomers continue seeking out natural and organic foods -- this is one food company investors may get a craving for.
Tsao covers financial markets for BusinessWeek Online in New York Edited by Beth Belton
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