Monday, February 2, 1998

Whole Foods Market Inc.
(Nasdaq: WFMI)
Phone: 512-477-4455
Price (1/30/98): $50 1/4


Want an organically grown Double? Shares of Whole Foods Market have sprouted this past year without the assistance of preservatives or chemical additives. As natural as the produce the health-conscious grocery chain sells, good old-fashioned business savvy has the company growing sales through well-timed acquisitions and improving margins.

With same-store sales up each and every year during the company's five years of publicly traded life, success was inevitable. In a rapidly growing niche within a relatively dormant supermarket industry, equity success came naturally.

The shares grew and investors harvested some welcome gains.


Whole Foods has grown from one grocery store in 1980 in the company's home state of Texas to 75 units sprawled across 17 different states today, selling organic and high-quality produce as well as other natural food items like farm-raised seafood and vitamin and nutritional supplements.


Income Statement
12-month sales: $1117.3 million
12-month income: $26.6 million*
12-month EPS: $1.05*
Profit Margin: 2.4%*
Market Cap: $1301.5 million
(*Includes non-recurring items)

Balance Sheet
Cash: $13.4 million
Current Assets: $113.9 million
Current Liabilities: $77.2 million
Long-term Debt: $92.7 million

Price-to-earnings: 47.9
Price-to-sales: 1.2


Economies of scale is a term often used to sugarcoat consolidators. The theory goes that a bigger chain will achieve certain operating efficiencies. Whole Foods was doing well until the axiom failed in 1996. After consecutive years of 32.6% gross margins, the larger grocer stumbled and only managed 31.7% gross margins in 1996.

While the company reported a loss for the year, due solely to merger-related charges, investors began to question the company's rapid-fire acquisition strategy. Where was the synergy if margins were contracting as the chain was expanding?

The drag came from the company's largest acquisition, Fresh Fields, a 22-unit natural food chain that initially sandbagged corporate performance and economies of scale believers.

The company turned itself and Fresh Fields around last year with 32.9% gross margin, laying the past to rest. Along the way, a stellar fifth consecutive year of same-store sales growth, this time to the tune of an 8.3% gain, found the company back on investors' shopping lists.

The rebound came in quarterly installments, and like competitor Wild Oats Markets (Nasdaq: OATS), the capital appreciation was definite, substantial, and gradual. Those who saw the fiscal improvement, those who didn't panic, hopped on the shopping cart early for the ride up the aisles.


The buyouts continue but are getting a bit more creative. In recent months the company has bought out an organic coffee roaster and a company specializing in mail-order vitamins and nutritional supplements.

As Peter Lynch would say, is this deworsification? Not really. Whole Foods was never about solely selling pesticide-free apples. One of its earliest acquisitions, the Unicorn Village in Miami, also ran a successful health food restaurant on the waterfront. Yet, specialty coffee and mail-order vitamins?

The Allegro Coffee Co. was already providing Whole Foods with The Organic Coffee Co. brand of java. The vertical integration made sense in buying out a supplier. With mail-order specialist Amrion the company not only picked up another growth vehicle in an explosive whole foods industry but also a low-cost manufacturer of vitamins -- again, more vertical integration -- buying out another supplier.

As for those economies of scale, the company now has a cost advantage over the typical mom and pop organic corner grocery store. It is why the company's net profit margin, at what may seem like a low 2.4% this past year, is actually well above the 1.5% average of not only plain vanilla grocers but even Wild Oats.

Then again, the company is selling for almost 30 times this year's earnings estimates and 23 times next year's projections. The company is in an exciting niche, and growing well enough to receive a decent premium over other grocers in terms of valuation, but the upside, in the near-term, appears limited -- unless one were to add some preservatives into the mix.

-Rick Aristotle Munarriz

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