Why Whole Foods is Cheap. Take Advantage of Mr Market’s Panic.

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by Dan Myers

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Before you read this article, read Jae Jun’s article on Whole Foods (WFM).

Whole Foods is one of those companies that has made me a better investor and person because I took the time learn about the company.

I am not the one that does the shopping in my house and I am certainly not the dietician in my house.

I eat a lot of garbage.

So this weekend, I was going through an informal screen, A.K.A goofing around in the web.

I found a list of debt free companies. 

I’ve seen these lists before and started to scan.  Most of the companies on there I like, but are just flat out too expensive.

However, I saw Whole Foods on the list. I found this odd and I also remembered an article coming out from OSV about Whole Foods. I honestly didn’t read beyond the title.

I was intrigued.

I went back and reread the thesis.  Here are the 3 ideas I got from it:

  1. Wal-Mart is not a threat
  2. CAPEX is evenly mixed between maintenance and growth
  3. The company is only beginning to ramp up its growth plans

The conclusion was that Whole Foods was fairly valued and is one you should just buy and sit on for the long haul.

After doing some more digging, I have to disagree.

This company is undervalued and this is a prime time to buy.

Why I Bought Whole Foods Market

There are 3 things I found that made me want to buy.

  1. No Debt
  2. Growth is slow now compared to their goals
  3. They have a pioneering culture

No Debt:  The Only Way I Shop

I’m going to continue to beat on this idea. Companies with no debt are more financially nimble and able to focus on shareholder value, not banker value.

Whole Foods has no long term debt.

This is from ValueLine:

WFM Capital Structure

WFM Capital Structure | Source: Valueline

The only long term obligation is $31 in capitalized leases. Their leases are all in their operating expenditures.

Also, with the stock price taking a hit, they are poised to buy back shares at this discounted rate. That certainly helps reduce the risk as a shareholder. Cash Flow is actually free and not promised to the bank.

The downside to no debt is that Whole Foods has had to dilute its shareholders a little. Whole Foods has sold shares on net for about $1.3B over the last 10 years. The worst part is that it sold over $400M of that in 2009 when the stock was at its lowest.

This is a concern and is dilutive to the shareholder base.

The Growth Story is Only Just Beginning

In 2014, Whole Foods is expected to open another 33-38 new stores. Currently, it has about 360 stores.

Per this Forbes article, Whole Foods wants to open an additional 1,000 stores in the next decade. Granted, these stores will be smaller, but that is almost tripling in size in a decade.

For arguments sake, let’s say the new stores are 50% the size of the existing portfolio.  That is the equivalent of 500 same size stores in a decade.  That would be 50/year. Whole Foods is currently at 33-38. It needs about another 33% bump in our current build rate to meet that goal.

That’s reasonable.

Whole Foods is accelerating the growth without getting ahead of itself.

Also, Whole Foods hasn’t had to finance its expansion in several years. It has all been done organically (there is a pun in there somewhere).

If I use 50/year, that comes to an annual 9% growth rate in store equivalents. This is just store growth. I haven’t discussed additional customers per store.

The trend is clear that people want to eat healthier. This expands their market and another 2% growth rate in same store traffic is reasonable as more people decide to eat healthier.

One new Whole Foods shopper for every 50 in an existing store sounds reasonable just on population growth.

Additionally, factor in price inflation.

The food industry is going through an inflationary time.  The question for grocers is whether or not they can pass on the price increases they are seeing to their customers.  If a company can pass along their inflation, then you can tack inflation on to their growth rate.

I look at gross margins for this metric.

WFM Gross Margins

WFM Awesome Gross Margins

Whole Foods has very tight and stable gross margins.

The range is 1.8% over the last 10 years.

Will Whole Foods be able to pass along costs? Yes.

So if inflation is 3%/year, which is where the CPI has historically shown it, then we can add that to our growth rate. A 3% increase in costs seems to translate into 3% increase in profits.

9% new stores + 2% new traffic + 3% price increases gets me to 14% growth rate per year without having to break a sweat.

A Good Culture Leads to Strong Results

Companies that take care of their people have people that take care of them.

Whole Foods believes in paying for quality.  They do so in paying their workers more than WalMart.  In turn, their workers provide a much more pleasant experience for the customers that are willing to pay more for their products.

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This isn’t hippie Marxist stuff.  This is just good business.

Another point to make about the culture is that it is very difficult to pinpoint the politics of the company.

In many businesses, you can tell which side of the isle the company is on.  Whole Foods takes stances that are on both sides of the political spectrum.  I’m not saying they stay neutral.  They do take stances, but they are not consistently on one side or the other.

Whole Foods CEO has taken the following stances:

  • Anti-Obamacare
  • Against Income Inequality
  • Business isn’t all about the profit motive
  • Business is the greatest value creator in the history of man

Take a look at this interview and see for yourself.

Having a culture that sees many different ideas and doesn’t just side with one political ideal is one that will be open to many new and innovative ideas.  This fosters a long term strategy of growth and sustainability.

Valuation is in the Mid $50’s

I see Whole Foods as a long term growth story.

I also see it as a very stable business model.  The customers are loyal to the company.  That means that in tough times, the company should be able to have minimal downside.  People still have to eat and Whole Foods customers are not ones to compromise health to save a couple bucks.

At the current Free Cash Flow of $858M, 14% growth from above and an 8% discount rate, I get a fair value of $54.90.

I used 8% because of their clean balance sheet and the fierce customer loyalty that makes their business much more predictable.  The more predictable the fundamentals, the lower the discount rate I use.

WFM Discounted Cash Flow Valuation

WFM Discounted Cash Flow Valuation


I see Whole Foods as a great long term investment. This is a situation where the stock price got ahead of itself and corrected.

Whole Foods is one company you should keep on your radar to buy when Mr. Market panics.

And Mr. Market seems to be doing just that.

Disclosure: Author is long WFM.

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12 responses to “Why Whole Foods is Cheap. Take Advantage of Mr Market’s Panic.”

  1. Hermann says:

    Great post. I like a lot about whole foods as well but I haven’t bought it. I agree with your numbers but their net income has some pretty narrow margins (granted so does walmart) and using the “equity bond” approach of a long term competitive advantage the current return is around 3.7% (1.47/38.79) I think?. Of course I haven’t done any analysis to see if net income is a good representation of expected owner returns :).

    I’m worried that they actually can’t respond to competition other than reducing prices. I’m also not a big shopper though I do like going to WF… that said if there was a cheaper store with same quality I’d go there… kinda feel that way about all non specialty retail. I don’t feel brand loyalty to department stores or grocery stores thus their success leads to commoditization where the company with the lowest cost wins (or the industry itself becomes share holder value destructive like autos and airlines).

    Of course the company could grow A TON before that happens and they may very well win both the price battle or the brand loyalty battle!

    Great post. Makes me want to dig more.

  2. that’s pretty much the consensus at the moment.

    But this also reminds of many situations where the consensus and news has literally scared everybody into thinking that a company is doomed.

    SBUX before Schultz came back, AAPL, MSFT, CSCO and the list goes on. As long as the company is agile enough to improve and try to do better, the situation has always turned around very well.

  3. Hermann says:

    Yeah, that’s true.
    I totally agree with both your numbers/analysis as well as this one. I also think that Walmart, Costco, etc are not really competition. Of course they COULD be, but I think a bigger threat is companies similar to whole foods competing and that the main way to compete is cost.

    So it sounds like you’re thinking that WFM might be able to create a brand value similar to Starbucks where even though I can buy coffee for $1.00 I i pay $4.50 for essentially the same thing (which I actually do… hmmm)?

    Maybe I’m too obsessed with the low net margins and discounting the potential growth too much? The companies above have much better margins (SBUX: 8%[2012, 2013 had that nasty litigation charge – hopefully one time], APPL: 20%+, MSFT: 20%+, CSCO: 20%+). If they can sustain a 14%-22% growth it seems like the value of the “equity bond” over 10 years could be healthy – even at 4% at year 10 I calculate it at around 14%. But… if they were at 8%+ I’d be much more convinced of price control and that would also be a nice buffer against competitors.

    Am I being too net margin focused? I WANT to invest in WFM because I like everything I see, I just can’t get past the margins and at those rates the potential for a long term commoditization – wherever it comes from – is concerning. I guess that’s why valuing is part art, part science… you can have a similar temperament and come up with very different conclusions. If I look at my own portfolio as it stands there’s some stuff in there that actually looks quite a bit worse than WFM.

    I need to get more consistent and rigorous… your site helps a lot!

  4. well if there is something that bothers you, definitely not a good idea to buy. You won’t be able to sleep.

    I’m not too concerned about net margins. Despite what the “news” is saying, WFM is still doing a lot better than the other copycats who need to spend a lot more compared to their size to try and catch up.

    And yes, I totally see WFM as a Starbucks. Lots of similarities in terms of brand loyalty. When shopping, it’s all about the experience.

    I’m willing to fight a traffic, parking and a heavy crowd to get things cheap.

    Not people like my wife and a lot of the people I’ve observed at WFM. They like to indulge in the store, check out things, take it easy and relax.

    Now back to margins, as food prices rise, WFM also has more buffer to play with compared to the competitors.

  5. Pablo Bernal says:

    Thanks for this great post.

    The only thing that catches my attention is the Debt. You mention that WFM has no debt but I think that their operating leases should be capitalized and expensed as depreciation and as interests accordingly. This would change the valuation considerably. What are your thoughts on this matter? Should we still consider WFM as debt-free or should we treat the Operating Leases as financial obligations and restate the Balance Sheet and Income Statement?

  6. WFM is extremely clear with all their numbers. Makes it so much easier to invest with them.

    They do this for you with their calculations in the PDF above.

  7. valueinvest says:

    I’m having a ton of trouble seeing where you got the $858M free cash flow number that underpins your valuation. How did that come about?

  8. Max says:

    seriously, you guys can’t identify who the competitors are for a grocery chain? hint: it’s NOT wal-mart.

    it’s OTHER regional grocery chains – kroger, safeway, wegmans, sprouts, natural grocers – that are increasingly offering more and more organic foods at reasonable prices, and thus driving traffic away from WFM. People don’t want to have to hit 2 different stores for their grocery runs if 1 will suffice.

    has Dan or Jae ever shopped at WFM, to take a look at the prices and offerings? the reason WFM stock has fallen recently is precisely because analysts didn’t believe WFM could increasingly “pass along costs” while still maintaining their margins in the face of price competition from other grocery chains with increasing organic choices.

    WFM’s stock price may recover some due to its well-known brand. But it hardly has the pricing power or market position of APPL, MSFT, CSCO, or SBUX.

  9. kroger, safeway aren’t really competitors because people don’t go there with “organic” shopping in mind.
    They go there, grab groceries and happen to pick up the organic stuff because it’s only a few bucks more expensive.

    The competitors are sprouts, wegmans. trader joes and other small chains popping up.

    And WFM offers everything in one location which is why they still continue to do well. The small local shops and community owned stores don’t offer everything like WFM.

    I doubt analysts have even stepped foot in WFM because they wouldn’t solely focus on margins without taking a look at the whole picture.

  10. Max says:

    Do you do the grocery shopping in your household? At our local regional grocer, they have a consistent and large offering of organic products along with the “regular” stuff. Not just produce…nearly everything – meats, breads, sauces, pasta, peanut butter, jam, cheese, soda, crackers, pretty much anything you can think of. I don’t need to go to WFM for organic foods; I can get it all at my regular grocery chain, and it’s hardly an afterthought. Organic choices are everywhere now at my regular grocery store.

    If WFM’s prices are 2-4x what regular chains are offering for the same stuff, would you do your one-stop shopping at WFM? Would you buy drinking water, toiletries, OTC meds, or your guilty-pleasure snack-foods for double price when you can get those items plus all the organic foods you want at the regular grocer? I visit Sprouts maybe once a month when they have good prices on certain produce, but they definitely don’t replace my regular grocery store.

  11. let’s be clear that WFM attracts a certain demographic. It’s why their SSS is still up 3.2% in the quarter.
    I buy the groceries myself, but I’m also not a WFM customer.
    I live in a small urban neighborhood where Kroger is 3 blocks away and Albertsons is 1 block away, WalGreens is across the road.
    I’m not an organic shopper for everything because as much as eating healthy and clean is important, it’s difficult to have a 100% organic diet.
    Now the real question and focus shouldn’t be about you or me because we are just 2 out of hundreds of thousands. Tiny sample size to be basing decisions on. Right now the numbers are doing the talking and the way I see it, WFM isn’t all about prices.

    If you invert the question, why is WFM still gaining SSS when the prices are so ridiculously high?

  12. vinvestor says:

    Came across this topic in seeking alpha about share dilution at whole foods which looks not that great.


    any thoughts on this ?

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