Heads -- Whole Foods Wins, Tails -- the Competition Loses

I admit it: I wasn't always an ideal role model for my younger brother.

When it came time to do the dishes at home, I took advantage of my brother's age (he was 4). The deal I made with him? "We'll flip a coin. If it comes up heads, I don't have to do the dishes. If it comes up tails, then you have to do them." Believe it or not, this actually worked for more than a year.

On a much larger scale, Whole Foods (Nasdaq: WFMI  ) has been able to play the exact same game when it comes to the grocery industry. Unlike me, it'll be able to keep playing the game for years to come.

Heads: Organics are here to stay
The move toward healthier, organic foods is an undeniable, long-term trend that is here to stay. The market for groceries is attractive for two fundamental reasons:

  1. This is an enormous market -- everyone needs food.
  2. The product is always in demand -- hopefully, three hearty meals a day for everyone.

From this large and sustainable market, organic foods have started to take up a larger slice of the pie.

Year

Total Food Sales

Organic Food Sales

Organic Penetration

1998  $454,140  $4,286 0.9%
2000  $498,380  $6,100 1.2%
2002  $530,612  $8,625 1.6%
2004  $544,141  $11,902 2.2%
2006  $598,136  $16,718 2.8%
2008  $654,285  $22,900 3.5%
       
CAGR 3.7% 18.2%  

Source: Organic Trade Association. CAGR=compound annual growth rate. Food sales in millions.

While the table above shows the strides that have been made so far, organic food still had just a tiny piece -- 3.5% -- of the entire food industry pie in 2008. That slice of the pie will undoubtedly grow as consumers educate themselves on where their food comes from.

Tails: Competitors have to eat their margins
But what happens when the cost of food rises suddenly? Flooding in Pakistan, droughts in Australia and Canada, and wildfires in Russia are putting a serious strain on the availability of food worldwide.

Because traditional grocers essentially offer the same products, the store with the lowest prices usually wins. No one is willing to pass the majority of the costs onto the consumer, in fears that they'll lose traffic. Whole Foods, however, can stand apart from the competition, as its customers have always been willing to pay a premium for quality food.

Company

4Q 2009 Gross Margin

4Q 2010 Gross Margin

Basis Point Change

Whole Foods 34.34% 34.57% 23
Kroger (NYSE: KR  ) 25.33% 24.35% (98)
Safeway (NYSE: SWY  ) 32.60% 32.06% (54)
SUPERVALU (NYSE: SVU  ) 24.92% 24.67% (25)
Wal-Mart (NYSE: WMT  ) 25.12% 25.10% (2)

Source: Capital IQ, a division of Standard & Poor's.

In essence, Whole Foods' competitors are paying more for the food they sell, and aren't able to charge their customers enough to make up the difference.

Foolish takeaway
As one of the only two retail pure-plays on organic food -- much smaller Fresh Market (Nasdaq: TFM  ) being the other -- Whole Foods still has lots of room to run before this growth story is done. And if there are bumps along the way, we know Whole Foods' loyal customers will provide the support that gives this company its edge during tough times.

You can follow this grocer's ascension to newer heights. Add the key players to your Foolish watchlist, and you won't miss a beat:

Fool contributor Brian Stoffel enjoyed spending all that time outside while his brother did the dishes. He owns shares of Whole Foods. Wal-Mart is a Motley Fool Inside Value pick. The Fresh Market is a Motley Fool Rule Breakers recommendation. Whole Foods Market is a Motley Fool Stock Advisor pick. Wal-Mart is a Motley Fool Global Gains selection. Wal-Mart is a Motley Fool Income Investor selection. Motley Fool Options has recommended buying calls on SUPERVALU. Motley Fool Options has recommended a diagonal call position on Wal-Mart. The Fool owns shares of SUPERVALU and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.


Read/Post Comments (4) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2011, at 10:59 AM, loumellet wrote:

    This commentary dismisses the entire notion of the aspirational consumer and what that means to Whole Foods sales.

    For reference, please look at same-store sales numbers at the onset of the financial crisis.

    "People gotta eat" is not a conclusive argument that Whole Foods stock is necessarily a good intermediate-term bet as it assumes that Whole Foods shoppers are 100% loyal, regardless of the economic environment. Moreover, it dismisses all notion of valuation, as it pre-supposes that Whole Foods will necessarily grow at its implied P/E multiples, the majority of which will come through new store openings and a "trade up" shopper.

    Suggesting that the "move toward healthier, organic foods is an undeniable, long-term trend that is here to stay" opens your supposition up for yet another black swan event, doesn't it?

    What would happen to unemployment and food budgets, for example, if the US economy double dips and the consumer confidence index sharply reversed its 18 month trend? More likely, what will happen to the Whole Foods aspirational shopper if Bernanke commits to a QE3, further exacerbating commodity pricing pressures on manufacturers, trucking costs and ultimately shelf prices? What happens if the housing market prices drop another 20%? Is the current direction of our economy a certainty? What happens to Whole Foods per store profitability if Tesco's Fresh & Easy format finds its footing or Trader Joes, Sprouts, Sunflower Markets, The Fresh Market and others flood California with viable formats?

    I reiterate that Whole Foods stock price and business are highly levered to the US economy. Isn't this outlined in Whole Foods 10-K almost immediately? Click here for a recent outline of Whole Foods risk/reward scenario, which is also posted on the Fool's "Is Whole Foods the Perfect Stock?" only a few short days ago.

    http://wp.me/p1oClO-S

  • Report this Comment On April 28, 2011, at 11:52 AM, TMFCheesehead wrote:

    @loumellet-

    All of what you offered are very real considerations to take into account before buying in.

    However, the phrase that I'll take issue with is "intermediate-term bet".

    Make no mistake about it, this is a long-term position for me...as in 10-20 years. Can I predict the future? Of course not, but I'm pretty confident in the organic food movement.

    And you're absolutely right in that an economic downturn akin to 08-09 would be devastating for the company's bottom line...for a while.

    As we've seen over the past four years, they've recovered quite nicely. And I believe, in fact, that downturns present an opportunity for them to gain market-share. During a downturn, I see other stores like WMT and SWY dropping their organic offerings as they wouldn't be as appealing (on a financial basis) to customers. When the upswing comes and customers can afford/choose to buy organics again, WFMI has an even stronger position.

    Brian Stoffel

  • Report this Comment On April 28, 2011, at 12:19 PM, BioBat wrote:

    The downturn in 08-09 wasn't nearly as crushing to WFMI bottom line as many bears would have you believe. It hurt, but that was no different than any other company that was out there. There's a reason WFMI came back with a roar last year and it was because they primarily attract the more affluent among us - and we weren't hit nearly as hard or not at all by the recession. This was before they got ultra competitive on organic pricing. I go to Whole Foods now and my bill isn't all that much different from a trip to Kroger.

    I agree with TMF on this one, WFMI is a long term hold.

  • Report this Comment On April 28, 2011, at 1:05 PM, portastatic wrote:

    The 08-09 downturn dip for whole foods also was exacerbated by the wild oats acquisition and the related kerfuffle with the FTC. Brutal timing.

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