The Big-Picture Buy Thesis for Whole Foods
"On Wall Street, they're in the business of making money between now and next Thursday. ... We want to build a company that will still be here 50 and 60 years from now."
Jim Sinegal of Costco uttered those words, but it also applies to Whole Foods .
With Wall Street dinging Whole Foods shares by roughly 20% since the company's latest earnings release on May 6, it's a good time to detail the big-picture reasons I believe Whole Foods will still be prospering five or six decades from now.
These are the same reasons that next week I'll be buying Whole Foods shares for the real-money portfolio I manage for The Motley Fool.
Let's begin here:
Whole Foods is a focused first mover
I don't care how many headlines there are that speculate otherwise: McDonald's will never be Starbucks, Taco Bell will never be Chipotle, and stores like Safeway and Wal-Mart will never be Whole Foods.
Those other concepts can try to copy, but they lack the focus, commitment, and authenticity to pull it off. Consumers may not be able to quite put it into words, but as a group they can spot a fake.
McDonald's is the best-run large-scale fast food company I've seen. I marvel at its efficiency and relative consistency around the world. But that distinctive McDonald's smell and the statues of Ronald McDonald just don't evoke the same upscale, relaxing coffee shop feel a Starbucks does. McDonald's will never be that "third place" for most of Starbucks' targeted audience.
While Taco Bell is associated with post-midnight "fourth meal" runs by frat brothers and jokes about the quality of its meat, Chipotle has a clean, higher-end feel and is all-in on "food with integrity." Taco Bell's Cantina Bell menu loses a lot of allure to typical Chipotle devotees when you can get gorditas, chalupas, and Doritos Locos Tacos at the same drive-through window.
It's the same way with Whole Foods. Traditional grocers and one-stop shops are adding organic food sections and offerings, but Whole Foods is all-in on organic. The company and its employees actually seem to care about organics -- rather than simply caring about losing market share to organics. The store experience (which we'll get more into soon) is vastly different at a Whole Foods versus a regular grocer, a Target, and certainly a Wal-Mart.
As for the clones that are popping up, even if they are adept at copying Whole Foods' playbook (very hard to do ... no one's yet successfully stolen Starbucks' or Chipotle's), they're playing well behind a first mover. If you combined the annual sales of Sprouts, The Fresh Market, and Natural Grocers, they'd equal about a third of Whole Foods' $13.6 billion in sales.
Meanwhile, Whole Foods is accelerating its pace of expansion to thwart the bandwagoners.
Just as Starbucks proved that America (and the world) had a desire for a chain of high-end coffee shops, Whole Foods has proved out the market for organic food. Others may imitate some of Whole Foods' pioneering moves, but it'll be hard to imitate the daily commitment to the cause. At the top level, you can see that commitment in the words and actions of Whole Foods co-CEO John Mackey. At a more granular level, you can see it in the helpfulness of its store employees. More on this soon.
Of course, winning is meaningful only if there's a prize to be claimed. Winning in organic food promises excellent opportunities.
Organic food is a megatrend, not a fad
A man starving on a desert island doesn't care if the chicken sandwich you just gave him came out of a trash can. Meanwhile, a child raised in an upper-middle-class suburb may know her GMOs soon after her ABCs.
For good or bad, prosperity brings with it higher expectations.
It seems a reasonable working theory, then, that 10, 20, 50 years from now we'll be caring more, rather than less, about where our foods come from. That leads me to believe the organic boom we've seen over the past quarter-century isn't going anywhere.
As Whole Foods itself reports, "Organic products have grown on average more than 20% per year over the last 7-10 years, making it the fastest growing segment of agriculture." Meanwhile, analysts see double-digit growth ahead.
In other words, the field Whole Foods dominates is getting bigger.
And Whole Foods isn't sitting still.
Whole Foods is wildly entrepreneurial
Not surprisingly, our co-founder Tom Gardner loves founder-led organizations. The logic makes sense.
Who would you guess takes better care of a child -- a child's parent or a hired caregiver? Intuitively, we know it's the parent.
In the same way, a founder has more inherent incentive to take care of what he's created than a hired-gun CEO would.
Well, Whole Foods is headed up by one -- co-CEO John Mackey. His dedication to the company versus the money is hard to question. Back in 2007, he dropped his salary to $1 a year, with future stock options going to charity.
He has guided Whole Foods' growth from one location in Texas in 1978 to almost 400 today, mostly in the United States. Perhaps more impressive than the growth is that these stores do something hard in retail -- they wow us.
I've lived in the same general area (a suburb of D.C.) for over a decade. In that time, I've had goodly exposure to two Safeways, two Harris Teeters, two Giants, and two Whole Foods.
"Entrepreneurial" is not the word I'd associate with the first three supermarket chains. "Standard" would be the word I'd choose. Some are nicer, some may have an in-store bank or coffee shop, some may be better staffed or cheaper, but they're all pretty much what you'd expect when you walk into a grocery store.
Just off the top of my head, here are some of the little entrepreneurial touches I've seen at one or both of the Whole Foods stores near me:
- Friday special: All week long, a sandwich board at the entrance announces the special for that Friday. It's something different but interesting each week. Think cheddar cheese or blueberries or flowers or pie. I admit to hoping each time that it's rib-eye steaks again.
- Make-your-own OJ: There are automatic juicing machines that let you make your own orange juice. For the convenience seekers, they also have some fresh-squeezed bottles next to them. It gives you that interactive feel of that big keyboard Tom Hanks jumped around on so famously. Depending on the store, you may also see similar things like a manned fresh guacamole station.
- Street food: At the one in Alexandria, Va., near Fool HQ, they set up a little street food kiosk each day at lunch featuring an item like pupusas or hot dogs. Sometimes they even grill burgers outside the store.
- Walk-up window: Meanwhile, at the Clarendon location in Arlington, which has much more foot traffic, they installed a walk-up window to sell freshly prepared rotisserie chicken.
- Sports bar: To cheat a little and mention a third Whole Foods in my area, the one in Fair Lakes has a full sports bar with 15 TVs (one's 90 inches!) and six beers on tap. The one in Alexandria doesn't have as much space, so it makes do with a space-efficient semi-oblong bar that gets quite a bit of lunchtime use.
- Produce presentation: At least in the D.C. area, Whole Foods' produce beats the quality I've seen at farmers' markets. Like most markets, when you enter a Whole Foods, you get funneled through the produce department to establish a feeling that everything's fresh. What's remarkable about Whole Foods is the care taken to present the fruits and vegetables. The colors and the order are striking. Paul Cezanne would marvel. For me, it's the bell peppers that do it.
- Special-occasion dominance: On Valentine's Day, the floral department in Alexandria took over much of the produce section to offer both pre-arranged bouquets and a custom flower arrangement section. Many Motley Fool marriages may have been saved that day.
- Coffee: I've noticed prominent advertising at both my Whole Foods locations that the coffee bar now opens at 7 a.m.
- Checkout enticements: When I check out at lunch in the express lane, each time I'm tempted by some dessert item upsell, often presented on ice. We're talking fresh fruit cups, strawberry shortcake, pudding, and the like.
From what I've seen, Whole Foods is darn good about competing to get you in often and making you feel like you're getting a premium experience and premium items once you're there.
Taken as a pattern, you can see that Whole Foods is smart about innovating at both the company level and the store level. A company that micromanages and doesn't have employee buy-in doesn't achieve the store experience Whole Foods does.
There's a reason Whole Foods employees are so knowledgeable and helpful and actually smile. More than most places in retail, Whole Foods employees seem to feel that the store and the company are theirs. Because they are. Over the entire history of Whole Foods, a mind-boggling 95% of stock incentives have gone to non-executives.
Furthermore, in teams, the employees are given real decision-making responsibilities at the store level. The profit from the resulting innovation and efficiency isn't just added to the bottom line -- it's shared when goals are exceeded.
It's relatively easy to steal the big ideas of one great entrepreneur. It's much harder to keep up with tens of thousands of them doing it on a daily basis.
Which helps lead to ...
When you offer an authentic, premium product and experience, you can charge a premium price for it. We see evidence of that in Whole Foods' gross margins. They sit in the mid-30s, while traditional grocers live somewhere in the 20s. That cushion of about 10% gives you the room to juice your experience, pay your people well, and still lead the industry in bottom-line margins.
It also allows you the leeway to think longer term.
Whole Foods is in the process of giving 1% of its gross margin advantage back. In fiscal year 2018, it expects to produce gross margins of 34.45%.
By lowering prices a bit on its food, particularly the staple items most folks compare across stores, Whole Foods is hoping to soften its "Whole Paycheck" reputation as competitors stream into the organic niche it pioneered.
Seems like a wise, long-term-business-building move to me.
The bottom line
Let's put this all in perspective.
Whole Foods shares fell the aforementioned 20% because Wall Street is focusing on increased competition. As John Mackey himself said: "For a long time Whole Foods had the field to ourselves, pretty much. That was nice. But we don't any longer."
Combine flat quarterly earnings with lowered guidance for the fiscal year, and that competition certainly seems to be manifesting itself.
But stepping back to the big picture, I'd rather be Whole Foods than any of its competitors.
Looking at Whole Foods' refreshingly longer-term five-year guidance, we're still looking at projected double-digit annual sales growth and annual same-store sales growth in the 5% to 6% range.
And looking out further, I see Whole Foods as a business that's going to continue thriving a half century from now.
If that's the case, you can ignore all the negative talk about mid-twenties price-to-earnings ratios, quarterly earnings disappointments, and slightly lowered gross margins and say something shocking ...
Whole Foods is a bargain.
The article The Big-Picture Buy Thesis for Whole Foods originally appeared on Fool.com.John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Anand Chokkavelu, CFA, owns shares of McDonald's and Whole Foods Market. Only because it's about Whole Foods, Anand's wife might actually read this article. The Motley Fool recommends Chipotle Mexican Grill, Costco Wholesale, McDonald's, Starbucks, The Fresh Market, and Whole Foods Market and owns shares of Chipotle Mexican Grill, Costco Wholesale, Starbucks, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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