Why I'm Staying Away From Most Natural/Organic Grocers

In this Johnny-come-lately industry, there are lots of pretenders trying to cash in on a popular trend.

Feb 15, 2014 at 8:00AM
Screen Shot

Source: Whole Foods Market.

Back in the late 1970s, a guy and his girlfriend -- college dropouts looking to reform capitalism and also members of a food co-op -- decided to borrow some money and start a food store. Friends could be forgiven back then for suspecting the venture would end in financial disaster.

But that's not what happened. The guy was John Mackey, and the store that he founded, Whole Foods Market (NASDAQ:WFM), has revolutionized the grocery business.

Since going public in 1992, the company has returned almost 8,000% including dividends. Success like that breeds competition. And in the last five years, traditional grocers have added substantially to their organic offerings, while boutique start-ups have taken advantage of an IPO-friendly atmosphere and taken their companies public.

In order of market cap, here are some of the nation's largest organic grocers.

Company

Line of Business

Brands (if applicable)

Whole Foods

Grocery

365 Organic

Kroger 

Grocery

Simple Truth Organics

Safeway 

Grocery

O Organics

Sprouts Farmers Market (NASDAQ:SFM)

Grocery

N/A

The Fresh Market (NASDAQ:TFM)

Grocery

N/A

Natural Grocers by Vitamin Cottage(NYSE:NGVC)

Grocery

N/A

Roundy's (NYSE:RNDY)

Grocery

Mariano's Fresh Market

But are all these grocers created equally? Personally, I'm not betting on it. Read on to find out which two companies stand to benefit the most from the ongoing movement toward healthy foods.

Thinning the pack
The first variable worth investigating will help thin this group out significantly. For a grocer to be considered a great natural/organic investment, it needs to have focused on this niche from the get-go. That means Kroger, Safeway, and Roundy's are out of the running.

All three could end up being great investments -- in part because of their organic offerings. Kroger is the second-largest seller of organic goods in the country, Safeway's O brand organics are competitively priced, and Roundy's is finding lots of success with its Mariano's stores in Chicago.

But in all three cases, natural and organic offerings are only a slice of the overall revenue pie, and dominance in the industry will come to those who are laser-focused on providing the healthiest food possible to customers.

Do they really "get" the movement?
One thing that has made Whole Foods such a successful venture is that Mackey is as much a health nut as he is a successful businessman. He has gone from being a vegetarian to a vegan to cutting out all oils and sugars from his diet.

Yes, he's eccentric, but he's also the father of the conscious capitalism movement in America.

While such a pedigree isn't necessary to find success in the industry, it's worth investigating if other companies even have a background that reflects the spirit of the food movement.

Company

Founders

Current CEO

Backstory

Sprouts Farmers Market

Stan and Shon Boney

Doug Sanders

The Boney family's stores were merged a few times under Apollo Management, most recently with Sunflower.

The Fresh Market

Ray and Beverly Berry

Craig Carlock

The Berrys were the most focused on changing the overall shopping experience to a more European feel.

Natural Grocers by Vitamin Cottage

Margaret and Philip Isely

Kemper and Zephyr Isely

When the Iselys founded the store nearly 60 years ago, the focus was squarely on healthy food and environmental friendliness. The company also penned the now famous "What We Don't Sell and Why."

Sources: Company websites.

I've spoken at length before about how The Fresh Market simply doesn't stand for anything in an age where to survive in this industry, businesses must clearly communicate their principles. Though CEO Craig Carlock has been with The Fresh Market for more than a decade, he started out with Procter & Gamble, which only adds to my reluctance about investing in the company. The Fresh Market is out of the running

With Sprouts, I have many of the same concerns. Though the company makes a big deal about tracing its roots back quite a ways, it is, in reality, the result of Apollo Management opportunistically merging one grocery chain with another. Sprouts employees only give the company a 2.6 (out of 5) rating on Glassdoor.com, and less than half approve of CEO Doug Sanders' job performance. This means Sprouts -- though it has performed quite well since going public -- is off the list as well.

For Natural Grocers, I'm actually willing to look past the company's negative Glassdoor reviews. While they are fairly low -- with an average 2.7 rating and only one-third of employees approving of CEO Kemper Isely's job performance -- there's more to the story. For starters, only 13 employees actually offered a CEO review, making the sample size very small.

But more important, this company is still in the family, and it is willing to forgo easy profits by refusing to sell GMOs, products with artificial sweeteners, colors, or flavors, as well as nonorganic produce of any kind. In addition, education is a key part of the Natural Grocers experience, and each store reportedly has a nutritional health coach who offers free guidance in picking the right products.

Which leaves us with two companies
Natural Grocers has also proven that it is capable of executing its growth plans. Over the past year, same-store sales have grown by more than 10% -- which is astounding for the industry. There are fewer than 100 locations nationwide, which means that there's tons of room for growth.

That may help explain why the stock is up 90% since the company went public. But investors should beware: The company's shares now trade for an expensive 75 times earnings.

Screen Shot

Source: Ammodramus, via Wikimedia Commons. 

What's good to know is that both Natural Grocers and Whole Foods -- the second great company to invest in -- can succeed in the end. Whole Foods has a much larger store size, which means that it tends to be located in heavily trafficked areas. Natural Grocers, on the other hand, is smaller and can succeed in more out-of-the-way locations.

However it shakes out, long-term investors who are willing to buy and hold for decades would be well-served by investigating these two companies as prime candidates for their portfolios.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Whole Foods Market. The Motley Fool recommends Procter & Gamble, The Fresh Market, and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. 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.

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