The Best Retail Stock for 2007: Whole Foods Market

I had ample ideas to choose from when given the challenge of picking a contender for the best retailer for 2007. After all, I enjoy following the universe of retail stocks, and I own a few of my favorites as well. However, when push came to shove, I had to choose Whole Foods Market (Nasdaq: WFMI  ) despite -- and partially because of -- the investor sentiment that soured on the retailer about midway through 2006.

Whole Foods Market is often known as a "supernatural" grocer, since it's a supermarket with a heavy emphasis on organic and natural products. You could argue that it has not only paved the way for specialty retailers such as Wild Oats (Nasdaq: OATS  ) and Trader Joe's but has also helped bring organic and natural eating trends into the mainstream. Thanks to Whole Foods' influence, conventional grocers such as Safeway (NYSE: SWY  ) and Wal-Mart have discovered that consumer interest in such offerings is far more than a fringe trend and have plunged into organics themselves.

The financial picture at Whole Foods has been exemplary, considering that the grocery industry was long considered a tired one with plenty of competition and low profit margins. Whole Foods changed that situation. It appeals to upscale and affluent shoppers and has managed to evoke the kind of lifestyle brand that Starbucks (Nasdaq: SBUX  ) has been so successful with. Also like Starbucks, Whole Foods hopes to appeal to consumers' desire for an enjoyable "third place" between home and work.

Whole Foods has delivered a 31% compound annual growth rate in sales since its IPO; as of the 12 months ending in November, it delivered $5.6 billion in sales. The five-year average same-store-sales growth at Whole Foods is 11.1%, and in fiscal year 2006, it was 11%. It's a highly profitable company, with a 2006 gross margin of 34.9%. At the end of fiscal '06, Whole Foods generated $453 million in cash from operations and had $256 million in cash on its balance sheet with very little debt. This retailer has been able to open new stores using the cash it generates in its business.

There are still more reasons to like Whole Foods -- and not just because it's so profitable that it has been able to pay a dividend to its shareholders. It reports economic value added, or EVA, which is a metric that provides a much more long-term approach than quarterly earnings. In addition, it gives abundant data on its same-store sales. Over the summer, we were able to take a look at that data and determine that Whole Foods is able to coax impressive sales growth out of older stores for what may be a remarkably long time.

Investors flipped out recently when same-store-sales growth mediated to lower levels than the torrid growth they had been accustomed to. Another reason the market soured on Whole Foods was the aforementioned new competitors such as Wal-Mart and the conventional grocers. However, I believe Whole Foods has a sustainable competitive advantage that is far more philosophical, and therefore more difficult to replicate, than what most businesses have managed to comprehend but may eventually find unavoidable to confront. Specifically, Whole Foods has been a pioneer in a more holistic approach to business and its power to make improvements in the world while making a tidy profit.

Whole Foods grew with the idea that businesses should benefit all stakeholders -- customers, shareholders, and employees alike. Call the budding movement "conscious capitalism" or what you will, but while 2006 was a year in which more and more people recognized the importance of corporate responsibility and environmental sustainability, Whole Foods has been a pioneer in that mindset. Meanwhile, the company bolted up to No. 5 on Fortune's annual list of best employers.

Furthermore, the idea of "food ethics" has been cropping up more frequently in books, magazines, and other mainstream media outlets. Although you could say that longtime customers of Whole Foods have long recognized the idea that low-priced foods from conventional sources might have more costs to the environment, communities, and animal welfare than many people are aware, it seems the idea is getting further dissemination and increased traction.

Last but not least, that brings us to Whole Foods' founder and CEO, John Mackey. He's been called a philosopher of the movement to link consciousness and capitalism, and that's part of why I nominated him a most Foolish CEO even before he decided to take a $1 salary and donate his stock options this past summer.

Whole Foods has fewer than 200 stores and plans to double its sales to $12 billion by 2010. In 2007, it has an aggressive growth plan in place in which it plans many store openings, some of which appear to be larger and more aggressive than before -- a few multilevel Whole Foods Markets are in the plans, for example. The company believes that its top 50 markets allow for a concentration of its stores, that it has further room to move into secondary markets, and that it has great opportunity for expansion internationally.

Mackey described 2007 as a transitional year for the grocer. While he described it as a year of growing store counts and continuing to focus on innovation to differentiate the company, investors chose to see the glass half empty, given competitive concerns. Of course, Whole Foods' guidance for sales growth of "only" 13% to 17% in fiscal 2007 and comps of "only" 6% to 8% gave the market cold feet. Its share price got trimmed by 40% last year, but it seems clear that 2007 will be a significant year, at the very least in terms of building on the company's strong foundations for long term gain.

Maybe I'm a bit of a contrarian to be so bullish on Whole Foods when the market has seemed to feel otherwise. But what do you think? Cast your vote in Motley Fool CAPS by tagging Whole Foods Market as an underperform or outperform. Next week we'll announce the community's idea of the best retailer for 2007, based on your responses.

Go back to the beginning to see what other retail stocks are in the running for our CAPS contest.

Whole Foods Market and Starbucks are Motley Fool Stock Advisor recommendations. To see what other great companies the Gardner brother have selected to outperform the market, take a 30-day free trial.

Wal-Mart is a Motley Fool Inside Value pick.

Alyce Lomax owns shares of Whole Foods Market and Starbucks. The Fool has a disclosure policy.


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