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Blue chip stocks are companies that have long dominated their industries, have strong competitive advantages, and are stable long-term investments. While blue chippers may not grow at the high rates of much smaller companies, their scale and competitive advantages usually lead to steady dividends to augment returns. For investors, that means stability and a relatively "safe" investment. Better to sleep at night.
Whole Foods Market (WFM) is one of the great stories of the past 25 years, having been one of the best stocks to own since the company went public in 1993:
WFM Total Return Price data by YCharts
Past performance is great for people smart (and lucky) enough to have bought years ago, but what does the future look like? Does Whole Foods have Blue Chip status in its future?
What's happening now?
Over the past year, the market has changed its tune on Whole Foods:
WFM Market Cap data by YCharts
Since October 25, 2013, Whole Foods has seen its market value fall from the most valuable grocer in the U.S, even though sales were only about 13% those of Kroger (KR -0.43%), to just over half Kroger's size. What's behind this significant drop in value? In short, competition and slowing growth.
Competition increasing
Kroger says its private label organic sales are growing at a double-digit rate.
The competition for organics has certainly increased, and this has correlated with a slowdown in sales growth at Whole Foods. Last November, Whole Foods reported that same-store-sales grew 5.9%, a number that most retailers would kill to get. However, when you averaged closer to 7% comps the year before, and almost 9% comps in 2012 -- and this growth is the reason the market is paying a premium for your stock -- this is a disappointing result. When it correlates with more competition, and what seems to be bigger players eating in your garden, the market is bound to respond negatively.
More than 100 Wild Oats products are now available at Wal-Mart. Source: Wild Oats
In April, Wal-Mart (WMT 0.57%), the largest retailer of groceries in the U.S., announced that it would be adding around 100 new organic and natural packaged foods from the "Wild Oats" brand to its stores, and that the organics would be priced at "about 25% less" than similar products from other brands. In its most recent earnings call, Kroger reported that sales of its house branded and price-focused "Simple Truth" and "Simple Truth Organic" products were seeing "strong double-digit sales and unit growth."
At the same time, Whole Foods' comparable sales growth continued to slow, falling to 3.5% last quarter. Needless to say, Mister Market isn't going to keep paying a premium for Whole Foods if it's not growing at a premium rate. As is usually the case, though, there's more to the story.
Aging stores a factor, too
There is undoubtedly more competition today than ever before, but there's also more consumer demand. Kroger COO Mark Ellis, from the recent earnings call:
... the natural organic customer is changing and growing in numbers. And those that shop the grocery store are also crossing over, and the blurring of grocery and natural foods is becoming more and more, when you look around the store and you can see organic items on the regular grocery shelves. So it seems that the customer base is getting much larger for these types of products. I don't know where the end is ... but we love the growth and we're going to continue to make sure that we have the products our customers are looking for.
So even Kroger is acknowledging that the market is getting bigger. Furthermore, there's no clear evidence that Whole Foods is losing business to traditional grocers. Kroger CEO Rodney McMullen stated that most of its sales aren't from customers only buying organics, but buying "from all over the store."
Whole Foods plans to update or remodel most of its oldest stores in the next year.
A little digging into Whole Foods' earnings report gives us evidence that there's another "problem": aging stores. Whole Foods is growing its store base at a rapid rate, and its a relatively young company, but 209 of its 386 stores at the end of last quarter are more than eight years old. This group of stores reported comp sales below 2% on average last quarter, and around 2.5% the quarter before. Of this group, more than 162 are at least 11 years old.
Whole Foods isn't ignoring this, either. Even as the company continues to grow its store base -- it has opened 33 stores over the past year -- it will update 70% of stores over 10 years old within a year. Co-CEO Walter Robb said, "(b)ased on the success of similar refreshes this past year, we expect these refreshed stores will see an immediate boost in comps, with the benefit to our overall comps more fully realized in 2016 and beyond."
This is in addition to the company's efforts to both strategically manage prices to make sure it's competitive, as well as -- and perhaps more importantly -- manage the "Whole Paycheck" perception that many consumers have -- a perception that's not completely fair or accurate.
Putting it all in the basket
Taken all together, Whole Foods' stock has "earned" the price drop as growth has slowed. However, the data doesn't really support that competition alone is behind the slowing comps. Furthermore, it's also critical to remember that Whole Foods' growth potential is enormous: The company has less than 400 stores today, compared to nearly 2,500 for Kroger, and more than 4,000 Wal-Mart stores with grocery items. Whole Foods expects to reach 500 stores by 2017, and is targeting 1,200 domestic stores in total.
With a price-to-earnings (PE) ratio today around 25, the market is essentially saying that Whole Foods growth will be moderate at best. The company is going to grow its store base almost 30% in the next three years, and remodel, refurbish, or relocate at least another 115 stores in the next year. Furthermore, the company is continuing to see its operating margins above 6.5%, easily the best in the industry.
Blue Chip future?
Honestly, it's going to be decades before Whole Foods is really approaching Blue Chip status, but that's because it has so much room to grow still. It has no debt, almost $800 million in cash, and a clear line of sight to continuing it's expansion. In the interim, it's remodeling older stores to reignite comp growth, continuing to pay a modest dividend, and seizing the opportunity to buy back shares at what looks to be a cheap price.
Blue Chip future or not, Whole Foods looks like a great company to own for long-term growth.
