Whole Foods Market, Inc. Has a Very Big Problem

Whole Foods is facing unprecedented competition, but management seems overconfident after the stock was hammered for weak earnings and guidance. Whole Foods has a very big problem, and the vision laid out by management ignores it.

May 12, 2014 at 6:50PM


Source: Counse on Flickr

Whole Foods Market (NASDAQ:WFM) has a very big problem. The stock got destroyed after the company reported disappointing earnings and slashed guidance, falling by as much as 20% the next day, but it was the tone of management during the conference call that was the most concerning.

Management laid out a five-year vision for the company, planning on rising margins and accelerating earnings-per-share growth, but this plan is at odds with the explosion of competition that is occurring in the natural foods market. Whole Foods is no longer the only game in town, and with other specialty grocers like Sprouts Farmers Market (NASDAQ:SFM) as well as traditional grocers jumping on the organic and natural foods bandwagon, maintaining its industry-leading margins will not be an easy task.

Overly optimistic
Co-CEO John Mackey admitted on the conference call that the company had been overly optimistic in regard to 2014 results, and pointed to a difficult comparison to a record 2013 as well as a rapidly changing competitive landscape. The company lowered guidance for the year across the board, with reductions in operating margins and EPS growth driving the stock, which traded at around 34 times earnings at the beginning of May, down 20% the next day. The company now expects EPS to grow by 3-6% in 2014, down from the previous guidance of 7-12%.

The theme of Whole Foods' conference call was that the company is getting more aggressive on lowering prices, but at the same time trying to ensure that the natural and organic foods market doesn't become a race to the bottom with regards to profit margins. Management stated that the company's focus on quality is what differentiates Whole Foods, but that is becoming a more difficult argument to swallow.

Trouble in Austin for Whole Foods
Austin, TX, the city where Whole Foods got its start and where the company's flagship store is located, offers an illustration of the competitive issues facing the grocer. HEB, a regional supermarket that Whole Foods explicitly mentioned during its conference call, has been ramping up its organic and natural food offerings. HEB also operates higher-end Central Market stores, which are very similar to Whole Foods locations.


Source: Mike Mozart on Flickr

Trader Joe's, also mentioned explicitly by management, has also recently opened a store in Austin and it plans to open two additional stores in the city very soon. Trader Joe's is notable for its vast collection of private label products, and the stores have somewhat of a cult-like following.

Sprouts, which went public last year and plans to rapidly increase its store base, also has three stores in Austin. Sprouts locations are smaller than those of Whole Foods, but the company shares the drive for quality food, as well as high prices. Sprouts grew its revenue by 22% in 2013 to $2.4 billion and managed a 5.7% operating margin which, while not quite as high as that of Whole Foods, is still well above those of traditional grocers. Sprouts plans to increase its store count by 14% in 2014, and the company currently has 167 locations to Whole Foods' 379.

Sprouts is notable because it shows that Whole Foods is not as unique as management seems to believe. It turns out that other companies can focus on quality and manage to be nearly as profitable. In fact, Sprouts had a slightly higher operating margin in 2013 than Whole Foods' operating margin in 2011. Sprouts seems to be following directly in Whole Foods' footsteps. The competition from Sprouts, combined with competition from traditional grocers, Trader Joe's, and all of the other specialty grocers, leads me to believe that organic and natural foods are inevitably going to become a commodity.

Lofty goals
Whole Foods is now getting more aggressive with its price cuts, it should be no surprise, then, that company expects this to lower its margins in 2014. The five-year vision laid out by management includes a steady increase in operating margin starting in 2015, along with consistent double-digit EPS growth. However, how the company expects to achieve this is unclear to me. The competition is only going to get worse for Whole Foods, and yet management is betting that five years from now margins will be at all-time highs.

Foolish Takeaway
Whole Foods is in a very different situation today compared to where it was even just a few years ago. Natural and organic foods have gone mainstream, and the days of little to no real competition are over. Co-CEO Walter Robb said during the conference call:

"So I think for a long time Whole Foods had the field to ourselves, pretty much. That was nice. But we don't any longer."

This sums up Whole Foods' big problem. Competition is going to drive down prices, and the plan to get the operating margin up to 7% by 2018 doesn't mesh with reality. Management admitted to being overly optimistic about this year, and then they turned around and were overly optimistic about the next four.

If you thought the internet was big
If you thought the iPod, the iPhone, and the iPad were amazing, just wait until you see this. One hundred of Apple's top engineers are busy building one in a secret lab. And an ABI Research report predicts 485 million of them could be sold over the next decade. But you can invest in it right now... for just a fraction of the price of AAPL stock. Click here to get the full story in this eye-opening new report.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Timothy Green has no position in any stocks mentioned. The Motley Fool recommends 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers