3 Potential Strategy Tweaks for Whole Foods Market in 2014

By most measures, Whole Foods Market (NASDAQ: WFM  ) has enjoyed another laudable year as the most visible pioneer in the natural and organic retail grocery space. The company's most recent quarterly net profit margin, at 4.07%, is nearly seven times the average industry net profit margin of 0.6%.Whole Foods enlarged its store count by 8% in the fiscal year ended Sept. 29 and increased average weekly store sales to an impressive $711,000 per store. The company has a pristine balance sheet, with almost non-existent long-term debt.Finally, Whole Foods stock kept even with the broader market in 2013, posting a total return of more than 28% year to date.

But 2013 was also a year in which Whole Foods seemed to grapple with a future in which critical mass will be reached, and an inevitable slowing of its phenomenal growth rate will occur. Comparable-store sales increases for the fiscal year departed from the heady 8%-plus rates of 2012 and 2011 and returned to 2010 levels, at 6.9%.That the company's stock did not outpace the S&P 500's year-to-date total return of more than 29% reflects investors' reassessment of the stock's near-term prospects. As Whole Foods closes out the first quarter of fiscal 2014 and we head into a new calendar year, what changes might we see in the company's corporate strategy designed to maintain its outperformance?

Image by Robert Banh under Creative Commons license.

Whole Foods may roll out its long anticipated loyalty program
In November, Bloomberg News reported that Whole Foods was in the process of testing a loyalty program, which would extend a discount of 10% on its private-label, "365" brand items.While investors have anticipated such a program for some time, 2014 may be the year we actually see it implemented.

Creating a loyalty program is a logical step for Whole Foods, as it opens a means to increased total customer visits. By discounting the 365 line of groceries, which includes many staples, the company can entice the customer who typically shops for only a few recurring items to switch to Whole Foods for weekly groceries. Each additional item in a weekly customer's shopping cart creates an offset to the margin lost in the incentivized (discounted) items.

For a higher-end chain, a loyalty program is almost more valuable as a method to increase traffic than as a retention strategy for current customers. But will a discount program lower the premium perception that surrounds Whole Foods and turn off current customers? Probably not. The North Carolina-based Harris Teeter grocery chain, which was acquired by Kroger (NYSE: KR  ) this past August, provides an example of an upscale grocer that successfully implemented a loyalty program. At the time of acquisition, Harris Teeter's loyalty program had a favorable view among its customer base that was 15 percentage points higher than the sentiment Kroger's customers held for its loyalty program, according to analytics firm DataRank. 

A debt issuance in 2014?
The past few years of Whole Foods' expansion have been almost totally self-financed,with the company using its strong operating cash flow to open new stores. However, with management recently expressing a desire to increase store count at a more aggressive pace in coming years, the company may be thinking about adding a reasonable amount of long-term debt to its books in the near future. This is because Whole Foods already allocates nearly 50% of its $1 billion annual operating cash flow to supplying common stock dividends to shareholders. In fiscal 2013, the company paid out $508 million of dividends and incurred fixed asset purchases of $198 million, along with $339 million of development costs for new locations.Thus, between returning cash to shareholders and adding new locations while maintaining current fixed assets, Whole Foods is near current capacity to self-fund further expansion. With the Federal Reserve already beginning to taper its monthly bond purchases, management may be even more willing to take on a bit of added long-term debt while the interest-rate environment is relatively favorable. You can be pretty sure that any debt issuance will be at a manageable level, in line with the the company's recent prudent balance sheet management.

Slightly smaller stores with a high return
One of the areas in which Whole Foods exhibits admirable discipline is its ability to keep average store size at a desired level, despite a mix of store sizes in both urban and suburban markets. Since 2010, the company has maintained an aggregate average store size of 38,000 square feet.This appears to be an optimal average store size for Whole Foods, which, as I have written about previously, allows the company to maximize what it believes to be its most important metric: return on invested capital. However, it's entirely possible that this average store size may actually decrease, if only by a couple of thousand square feet per store, over the next several years. Whole Foods is beginning to penetrate smaller suburban markets, some of which have populations as small 200,000 to 250,000. Smaller stores in more diminutive markets may be the key for the grocer to reach its recently revised long-term goal of opening 1,200 stores. Shrinking retail footprints come with another advantage: they lend themselves to higher sales per square foot, which is another metric closely watched by Whole Foods' management, and its investors as well. 

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Read/Post Comments (12) | Recommend This Article (21)

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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 December 25, 2013, at 6:23 PM, cmalek wrote:

    WFM caters to the "upscale" customer and there are relatively few of them in the US. Soon WFM will run out of upscale neighborhoods to expand into. They will either have to compromise their "values" and start catering to the hoi poloi (those that are price-sensitive) or expand internationally.

  • Report this Comment On December 26, 2013, at 1:40 PM, PatCampbell wrote:

    Here in Vancouver, WA we've had a WFM for most of a decade. Trader Joes, New Seasons, and Chucks have moved in since and although they provide related competition in some ways they do not provide the whole enchilada which includes moderate prices, variety, and person to person service. Our WFM's parking lot is still full and not with just upscale customers. We have a lot of retirees of relatively modest mean who have moved here for the beautiful environment, moderate home prices, cheap utilities, and no income taxes.

  • Report this Comment On December 26, 2013, at 1:48 PM, TMFfinosus wrote:

    Hey cmalek, whaddup?! Touche again.

    Have you ever wondered why, after all these years, WFM hasn't expanded internationally? I often do. I think they are really trying to understand how to optimize their business across a variety of environments (urban, suburban, high density / high income, high density / moderate income etc. &etc. before international expansion.

    Disagree with you because I believe that WFM is experimenting with how to succeed in smaller (and often less wealthy) markets. Check out this article: http://goo.gl/3BBkfC

    Plus, why are you hating on their values?

    Best,

    Asit

  • Report this Comment On December 26, 2013, at 1:53 PM, TMFfinosus wrote:

    Hi Pat,

    Thanks for commenting. I agree that WFM provides an overall solution. Personally, they still don't have all of the grocery business in my house. We split between Trader Joe's, WFM, Harris Teeter, and Food Lion (which you probably haven't heard of but is local to the U.S. southeast). We split on the basis of price and stuff we like at the different stores (all are close by our house). But WFM seems to get more of our business every year. With a good loyalty program, I could see them taking a bigger bite out of our monthly budget.

    Vancouver itself provides the whole enchilada, doesn't it?

    Thanks,

    A

  • Report this Comment On December 30, 2013, at 11:36 AM, Gary1putt wrote:

    There is an unfortunate use of a word in the first sentence. The USDA says when it comes to food the word "natural" is meaningless.

    And there is international expansion. There is even a store in Scotland.

  • Report this Comment On December 30, 2013, at 11:41 AM, GeeBeeNC wrote:

    The Whole Foods stores in the RTP area of North Carolina have heritage in Well Spring Grocery, a localchain that was absorbed by WF. The old Well Spring Stores have resisted the corporate blandness at least enough that management should ask what makes these stores more personable than the created from scratch locations.

  • Report this Comment On December 30, 2013, at 12:09 PM, TMFfinosus wrote:

    Gary1putt,

    I think you have a point about the USDA re the word "natural." But I'm conflicted regarding using it as a descriptor in grocery articles, because it's come to help define a category of stores. Personally I'll probably continue to use the word to describe WFM, due to the very concrete principles they have adopted around their particular idea of natural (no trans fats, non-GMO etc).

    On international expansion, I think you're referring to my response to a previous comment? I've written about WFM's presence in UK & Canada before, didn't mean to imply that they don't have some global presence. Just now it's minimal compared to their size however.

    Cheers,

    Asit

  • Report this Comment On December 30, 2013, at 12:12 PM, Weitzhuis wrote:

    It's still Whole Paycheck to me and i don't like their pandering to the anti-science anti-gmo crowd either. What's next? Screen and ban customers who've had the GMO derived flu vaccine?

  • Report this Comment On December 30, 2013, at 12:14 PM, TMFfinosus wrote:

    Hey GeeBeeNC,

    Long live Wellspring! I went to summer camp as a young teen in Durham and also went to Science & Math in high school. Totally agree with you on the character of those stores. The cafe at the Wellspring on Broad was one of my favorite haunts -- still head over there for a coffee on either side of a Cosmic Cantina run. I actually think some of the Wellspring ideas found their way into the current standard store; WFM was very young when they acquired those three or four locations.

    Best,

    Asit

  • Report this Comment On December 30, 2013, at 12:24 PM, TMFfinosus wrote:

    Hi Weitzhuis,

    I'm guessing it will take more than a 10% discount on 365 items for WFM to get your business? You may disagree with their stance on non-GMO, but I wouldn't say they are pandering to a particular set of customers. They're simply putting out (and living by) their particular set of corporate values, in my opinion. Of course that's easy for me to say, because the company does do gangbusters business with customers who avoid gmo foods.

    Thanks for weighing in,

    Asit

  • Report this Comment On December 30, 2013, at 1:16 PM, SkepikI wrote:

    Whole Paycheck, the Tiffany & Co of the grocery business is significantly more expensive than alternatives for the frugally discerning shopper. WFM was believe it or not, a LATE ENTRY to the Portland OR area, and their competition in some areas is lower priced, better quality and equally interesting - IF you are a discerning shopper....

    On the other hand: They have been VERY ASTUTE in selecting their locations to gather in the upscale, less frugal and "pseudo discerning" who enjoy the WFM shopping experience. Their lots tend to be filled with Lexus, Volvos, Audi and BMW's. When they are full. One store near me RARELY has a full lot, or a full store. If it continues to be a miss for WFM, it will be a lone or infrequent miss.

    Bottom LIne oriented corporate values, I reckon, based on performance. Cream off the upper end of the customers, solidify them as your base and enjoy a great margin in a tough business. You have to admire that. I dont admire the prices, but if you can get it, GO FOR IT!. Just dont be bamboozled thinking they are better than they are or have little competition.

    In FACT, thats the best recommendation I can think of to believe they are a superior enterprise: winning in the face of remarkably stiff competition.

  • Report this Comment On December 30, 2013, at 3:11 PM, GeeBeeNC wrote:

    Asit,

    I sent you an e-mail.

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