Shares of Whole Foods Market (NASDAQ: WFM ) were pummeled after the company reported disappointing earnings on May 6, 2014. Given the poor results, Wall Street analysts followed up the release by lowering their ratings on the stock. The reason for the poor performance? Things have gotten competitive in the market for fresh, natural, and organic foods, perhaps faster than either Whole Foods or its investors anticipated.
Smaller players like Sprouts (NASDAQ: SFM ) and The Fresh Market are growing - quickly. In addition, supermarkets are expanding their natural and organic food sections in an effort to get a piece of the natural food pie. Even Wal-Mart (NYSE: WMT ) plans to stock its shelves with more than 100 organic items.
Given all of this competition, Whole Foods' slowdown probably shouldn't have come as too big a surprise. But Whole Foods has been the key driver in the space for years, and it had so far been able to navigate the increasingly crowded waters deftly enough to grow and stay profitable.
Has Whole Foods become the victim of its own success?
A timely shift to 'value'
First off, the numbers were not terrible for the quarter. Sales were up 10%, year over year. Comparable-store sales were up 5%. Analysts were expecting a 7% comps number.
One reason for the disappointing numbers is that Whole Foods has had to keep a lid on price increases. The 1.7% increase in average price per item was the lowest quarterly increase in three years.
A particular concern for investors is Whole Foods' "value strategy," something that's likely a direct result of the increasing competition in the space. The company acknowledges that the shift to selling items at a better bargain is hurting both sales and margins. But it also believes it is key to gaining share moving forward, something Co-CEO John Mackey says will result in higher sales down the road.
Whole Foods is looking to capitalize on the growing awareness of eating healthy and natural. With shoppers now more likely to peruse the natural and organic foods aisles of their supermarket, Whole Foods sees this as a time when it can reach out to a much broader crowd than it had in years before.
The question now is whether this is just the beginning of a long transitional period, or it's a case of the proverbial darkness just before the light.
It's working for competitors
Skeptics have been quick to question Whole Foods' value strategy. But the grocer is hardly out on a limb here. Sprouts has been taking a similar approach and credits it with its record first-quarter financial performance that outperformed company guidance, as well as its 28th consecutive quarter of positive same-store sales growth – up 13% this time around.
"Sprouts' focus on value is resonating with a broad and growing base of customers who now have the opportunity to purchase healthy food at an affordable price," CEO Doug Sanders told analysts. Sprouts' revenue was up 26% over the prior-year quarter.
With Wal-Mart and other larger players entering the space, the need to competitively price will only increase.
Whole Foods still has big plans
Whole Foods is maintaining ambitious growth plans. The company, which now operates 374 stores, has a record 114 more in development. It plans to have 500 stores in the U.S. by 2017, and sees its long-term potential at 1,200 U.S. stores, more than three times the number it now has.
It expects sales to increase by 75% over the next five years.
Optimistic references to "2015 and beyond," are not playing well on Wall Street right now. But Whole Foods remains the biggest driver in natural foods and the most recognizable name of the grocers specializing in the natural and organics space.
The Foolish bottom line
When a new restaurant opens in a neighborhood, other restaurants nearby suffer in the short term. But over time, diners patronize the places where they get the best food and best service at the best price.
That's what Whole Foods is looking to position itself to be in the long term. It won't happen overnight, and there may be more tough quarters ahead – the company would not have revised its guidance if it didn't expect there to be. But Whole Foods has a long track record of success, and the market for the products its worked so many years to promote may just now be starting to reach its potential.
Whole Foods might not be done falling, and the transition back to more robust growth may not be a speedy one. But investors with a tolerance for risk and a long-term view should consider giving John Mackey and Whole Foods management the benefit of the doubt.
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