Whole Foods Investors Need to Focus on the Bigger Picture

Whole Foods Market (NASDAQ: WFM  ) reported first-quarter results last week and its shares dropped by nearly 8%. The grocery chain reported lower revenue and profits than expected and issued a weaker forecast for 2014. Whole Foods continues to add stores but it faces increasing competition from The Fresh Market (NASDAQ: TFM  ) and Sprouts Farmer's Market (NASDAQ: SFM  ) . However, the store remains one of the most famous health food stores and it has a newly signed deal with Square to begin offering mobile payments at its registers. Also, the first quarter wasn't as bad as it seemed.  

Source: Herry Lawford

A weak quarter for Whole Foods still looks pretty healthy. Revenue grew nearly 10% to $4.2 billion. Comparable-store sales were up over 5%, which was down from the prior quarter's growth of nearly 6%. That doesn't paint as pessimistic of a picture as it may seem. Why shouldn't investors worry about the comps slip?  

What caused comps growth to slow?  
Inclement weather hit retailers in general this quarter. Whole Foods execs also acknowledged during the conference call that cannibalization has become an issue in some larger markets such as Boston. Whole Foods ended the quarter with 307 stores, another 100 in development, and the goal of having more than 500 stores in total by 2017. Long-term, the company sees the potential for over 1,000 stores. So cannibalization will likely remain an issue in certain markets.

The breakdown of comps by store age shows that the comps deceleration comes from an aging fleet of stores. 

Source: Company filings 

Nearly a quarter of Whole Foods stores fall into that 15 years-or-older category and more than half were opened at least eight years ago. The two oldest categories each had comps of 3.2% for the quarter, which was considerably lower than the nearly 20% growth for the stores which were younger than two years. However, that's not the full story. The older stores have far higher returns on invested capital, or ROIC. Here's how ROIC breaks down by store age: 

Store age

Q1 Comps

ROIC*

>15 years

3.2%

115%

11-15 years

3.2%

92%

8-11 years

3%

88%

5-8 years

7.3%

44%

2-5 years

6.6%

26%

<2 years

19.5%

2%

*ROIC: "Defined as annualized store-level income after taxes divided by average invested capital; does not reflect any as-if effect of capitalizing operating leases"

So older stores decelerate on comps but they have far higher ROIC since the company doesn't need to invest as much money into their operations. The overall comps rate remains reasonable when matched against the competition.

Where do The Fresh Market and Sprouts Farmer's Market stand?   
Whole Foods' most directly comparable competitors are privately owned Trader Joe's, The Fresh Market, and Sprouts Farmer's Market. The Fresh Market's third-quarter report in November included a comps increase of over 3% but the store missed analysts' estimates with revenue of $364 million and $0.23 in earnings per share. Estimates for the first quarter include $364 million in revenue and EPS of $0.43.  

Sprouts' third-quarter report included comps growth of 10.2% with revenue growth of 24% to $634 million. However Sprouts, which went public last summer, only has 160 stores and so the company finds itself near the start of its growth story where double-digit comps are expected if everything's going well. 

Foolish final thoughts 
Whole Foods stores face comps deceleration with age. The degree to which this deceleration impacts Whole Foods' overall comps will increase as more stores join the "old age" categories -- assuming there's not a balancing number of new stores added to the mix. However, the ROIC numbers show that the stores aren't short on potential. The growth story of Whole Foods might change, but that doesn't mean the company's finished growing. 

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