Did Wal-Mart Just Kill Whole Foods' Competitive Advantage?

Wal-Mart Stores  (NYSE: WMT  ) is moving forward with a deal with Wild Oats, a privately held maker of organic and natural packaged foods, to roll out around 100 products to 2,000 of its domestic stores this year. Is this going to destroy Whole Foods Market's  (NASDAQ: WFM  ) competitive advantage by removing the premium that consumers have been willing to pay for organics? 

After years of market-beating returns, is it finally time for investors to move on from Whole Foods?

An amazing growth story

WFM Total Return Price Chart

WFM Total Return Price data by YCharts.

Whole Foods has been a truly life-changing stock for early investors. If you invested $1,000 on the day of Whole Foods' IPO in 1992, that investment would be worth more than $73,000 today. Investing $1,000 in 2000 would also have paid amazingly well during the 14 years since, netting a return of more than $9,200.

Whole Foods now has 374 stores, with another 10 in development, and has largely had little competition for the high-end produce, prepared foods, and organics that it sells.

Already feeling the squeeze?
This lack of competition has partly led Whole Foods to industry-leading operating margins:

WFM Operating Margin (TTM) Chart

WFM Operating Margin (TTM) data by YCharts

Because Wal-Mart sells much more than groceries, Kroger offers some context to just how strong Whole Foods' operating margins are. As you can see, we're talking essentially twice that of one of the largest grocers in the world, whose scale should give it tremendous pricing power and operational efficiencies.

If you look closely, you'll see how, in the most recent quarter, Whole Foods' operating margin is declining, falling from almost 6% to 5.65%. Management specifically talked about competitive threats, and said that it would be working to be price-competitive as mainstream grocers -- like Wal-Mart and Kroger -- expand their offerings of organic and better-for-you packaged and fresh foods. 

What will the Wal-Mart expansion look like?
As it stands, Wild Oats' website only lists 15 organic food categories, and three "natural" food categories. Wal-Mart's website currently lists 31 different Wild Oats Organics products. While we know that the initial rollout will include about 100 products, the question is, how many more products will be added in the future? Wild Oats Organics brand products will -- according to Wal-Mart -- be priced up to 25% less than similar name-brand organic products. It's easy to see how this could be concerning for retailers like Whole Foods. 

Adding a lot of organic items to its shelves in half of its U.S. stores is a clear indication that organic and "better-for-you" packaged foods are here to stay, and Wal-Mart isn't playing around. Within months, Wal-Mart will have these products in more than six times as many stores as Whole Foods operates in its entirety. That has to be a threat, right?

Stopping there, however, ignores Whole Food's real strength
The reality is, this is less of a threat to Whole Foods' business, and more of an additional validation that organic, sustainably grown food is becoming mainstream. More consumers are becoming aware of the potential health implications, and maybe more important, the ecological impact of unsustainable conventional farm practices. At the end of the day, this is more data to support Whole Foods' decision to increase its targeted store count from 1,000 to 1,200.

Here's the key: The average Whole Foods customer doesn't shop at Whole Foods based solely on price. Don't get me wrong... all consumers want value for their dollar, but Whole Foods customers know that they can pick up any product on a shelf in their local Whole Foods store and it will meet certain standards in terms of the ingredients and the practices of the company that produced it. They'll also know that the farmer who produced it was paid fairly. 

Can you get that at Wal-Mart? Not even close. After all, even if Wal-Mart stocks hundreds of organic products on its shelves, the majority will still be the conventional stuff that most Whole Foods shoppers are trying to avoid. Add in the amazing selection of (high-margin) prepared foods that Wal-Mart and other grocers won't compete on, and Whole Foods' competitive advantage remains as strong today as ever. 

Final thoughts: Wal-Mart acting because of the opportunity

US Grocery Store Sales Chart

US Grocery Store Sales data by YCharts.

The grocery market in the U.S. is enormous -- more than $550 billion in 2013 -- and organics is the fastest-growing part. Wal-Mart grew sales just more than a paltry 1% -- that's less than inflation -- last year. Expanding its grocery business into a growing market is a must for this retail behemoth. The reality? The Krogers of the world probably will feel more of an impact than Whole Foods. 

Nonetheless, facing new competition is the reality for any growing business; Whole Foods is no exception. Seeing a titan like Wal-Mart move more heavily into organics isn't the threat it seems on the surface. If anything, it's more of a validation that the market is much bigger today than it was when Whole Foods went public in 1992. I don't know about you, but I'm holding my shares: The future looks pretty big from here.

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Read/Post Comments (12) | Recommend This Article (3)

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 12, 2014, at 8:31 AM, Charlotte49er wrote:

    Saying that Walmart will steal Whole Foods customers is just as idiotic and short sighted as when David Einhorn said Taco freakin Bell would steal Chipotle Customers. Do Hyundai and Kia steal Audi customers?

  • Report this Comment On April 12, 2014, at 1:49 PM, TMFVelvetHammer wrote:

    >>Saying that Walmart will steal Whole Foods customers is just as idiotic and short sighted as when David Einhorn said Taco freakin Bell would steal Chipotle Customers. <<

    That's actually mostly my point, if you read the article. However, your example:

    >>Do Hyundai and Kia steal Audi customers?<<

    Actually, yes. I'm pretty sure Hyundai's Genesis has taken a lot of people out of A4s. :)

    I tease, because yes, your underlying message is spot-on. It's not a price thing. Or should I say, *just* a price thing.

    Thanks for your comment.

    -jh

  • Report this Comment On April 12, 2014, at 2:06 PM, Charlotte49er wrote:

    Jason, awesome article and very well said! I was just venting because I've been reading allll week everywhere I look about how Walmart will cause the downfall of WFM. Sorry to come off as combative when I actually agree 100%! Nice work and keep the articles coming!!

  • Report this Comment On April 12, 2014, at 3:47 PM, farnal wrote:

    I agree with Charlotte49er. Whole Foods customer base is distinct from WalMart's. The natural and organic aspect is just a small part of their appeal. Their core target is people who are really into food ("foodies"). Few grocers present such a high quality array of produce, prepared foods, fresh top drawer meats and seafood along with knowledgable and friendly staff to serve you.

    Whole Foods has set the bar for conventional supermarkets as well as other niche marketers like The Fresh Market, Sprouts Farmer Market, etc.

  • Report this Comment On April 13, 2014, at 1:33 PM, SIRIking wrote:

    Another idiot writer who writes out of his rear without using fair portion of his brain cells. If anything walmart will steal sprouts and other grocery stores Organic customers NOT Whole Foods Market!

  • Report this Comment On April 14, 2014, at 11:46 AM, cgsevern wrote:

    As Whole Foods CEO said last week in an interview, Walmart is only going to get packaged foods in this deal with Wild Oats. They don't have the in-roads into organic produce that Whole Foods has developed over many years. For those of us in cities with limited ability to go to a farmers' market (think southern desert areas Nevada, Arizona, etc.), Whole Foods is an organic fresh food oasis. We have 3 Whole Foods Markets within a 10 mile radius of my home. I visit all 3 and can attest to the popularity. The shoppers I see in Whole Foods are not going to visit Walmart for groceries.

  • Report this Comment On April 14, 2014, at 12:08 PM, TMFVelvetHammer wrote:

    >>Another idiot writer who writes out of his rear without using fair portion of his brain cells. If anything walmart will steal sprouts and other grocery stores Organic customers NOT Whole Foods Market!<<

    SIRIking,

    It almost sounds like you didn't read the article. My conclusion in the article is that Wal-Mart's move doesn't impact Whole Foods' competitive advantage. Don't shoot the messenger if you don't, well, actually read the message...

    -jh

  • Report this Comment On April 14, 2014, at 11:21 PM, discobolus wrote:

    You chart showing grocery sales overstates the real growth, as food price inflation over that period has been extraordinary.(despite the lies Washington statistics would have us believe)

    Agree fully that WM's entry will help raise a "rising tide" of organic/wholesome food growth, and broaden the base...but serious a downturn in the economy will send a large percentage running back to cheaper mainstream,items.

    For now, I'm with you and taking a stake (not steak!) in WFM.

  • Report this Comment On April 15, 2014, at 12:52 PM, TMFVelvetHammer wrote:

    >>You chart showing grocery sales overstates the real growth, as food price inflation over that period has been extraordinary.(despite the lies Washington statistics would have us believe)<<

    This may be true in terms of its affects on consumers, but it doesn't overstate the point that It's a growing source of revenue for grocery sellers.

    And while food inflation is a real problem, food costs as a percentage of the average household's expenses is still much lower than 50 years ago.

    >>...but serious a downturn in the economy will send a large percentage running back to cheaper mainstream,items.<<

    Another thing that I think you'll agree adds to Whole Foods' competitive advantage. Most of its customers are relatively immune to an economic downturn when it comes to deciding where to buy groceries.

    Thanks for your comments!

    Jason Hall

  • Report this Comment On April 27, 2014, at 11:56 AM, Bluetugboat wrote:

    Thank you for your insight.

    There are two considerations here for WFM: defensive and offensive.

    The defensive view is, "Will Walmart's move into this organic space SUCK WFM customers to Walmart?" There are reasons, enumerated above, that say this won't be a huge worry. WFM customers believe they're part of a bigger "movement" or "experience", if you will, that doesn't judge everything on price.

    The offensive view is, "Will Walmart's move into the organic space translate traditional Walmart customers into organic consumers?" Additionally, "Will Walmart's move into the organic space KEEP customers from moving to buying at WFM?" That question is up for debate, and I think geography will play a huge role: expect to see many more coastal shoppers in or just outside of major metropolitan areas getting on the organic Walmart train. That's just a prejudice, however: I look forward to seeing how this actually shakes out.

    One last thing: to those who characterize the opinions of others that they haven't even met as "stupid" or "idiotic" is just darn rude. Please remember your manners when you're disagreeing with people, especially strangers.

  • Report this Comment On May 02, 2014, at 4:00 AM, jmccp wrote:

    You make another clear mistake in your statement: <<If you look closely, you'll see how, in the most recent quarter, Whole Foods' operating margin is declining, falling from almost 6% to 5.65%>>

    The line you refer to is Wal-mart, not Whole Foods. Look at the chart you above your quote. LOL. Wal-marts margin is dropping that much. Whole Foods dropped very little.

    Also you and many others do not seem to understand the loyal customer base Whole Foods has. People shop there, even paying more because they can trust anything they put in their stores. This is important when considering why people go to organic foods in the first place. With a world full of genetically modified products, pesticides, unsafe additives, etc. it makes a lot of sense to many people to shop Whole Foods. This argument of Wal-Mart taking over has been posted in articles many years ago. I for one am glad that I stayed with Whole Foods over the past 7 years and have seen a 4-fold return in my stock with them. I read articles like this back then. There is a reason Stock Advisor and others here have highly recommended this stock. Even Cramer has highly recommended it for many many years. When the stock is down some like this I buy more shares and trade around a core position and sell just those additional shares when the price gets higher again.

  • Report this Comment On May 02, 2014, at 11:35 AM, TMFVelvetHammer wrote:

    jmccp,

    Good catch. All I can say is I was thinking Whole Foods which did decline from 6.9% to 6.79% QoQ, but I think what you're missing is my conclusion:

    >> Seeing a titan like Wal-Mart move more heavily into organics isn't the threat it seems on the surface. If anything, it's more of a validation that the market is much bigger today than it was when Whole Foods went public in 1992. I don't know about you, but I'm holding my shares: The future looks pretty big from here.<<

    In short, I'm also long Whole Foods and have been for years. I have the same view as you on the company and the stock.

    -jh

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