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For well over a decade, Whole Foods Market (WFM +0.00%) was the only pure play in the organic food movement. The company was enormously successful, and that garnered investors a return of almost 1,000% between 2000 and 2013. But others took note of that success, and it hasn't been pretty in the industry since then.
On the low end, Wal-Mart, Costco, and Kroger have significantly upped their organic offerings. On the high end, a number of specialty stores have given Whole Foods a run for its money. One of those high-end purveyors is Sprouts Farmers Market (SFM +6.52%).
Today we'll look at whether Sprouts' or Whole Foods' stock is a better buy.
Financial fortitude
As boring as cash in the bank might be, its importance cannot be understated. When a company has a cash hoard sitting around, and doesn't have to worry about meeting debt payments, it has options and flexibility. If the economy sours, it can outspend rivals, buy back shares on the cheap, or even make an acquisition or two.
But if there is no cash stash, then options are extremely limited. That's why financial fortitude is so important.
|
Company |
Cash |
Debt |
Net Income |
Free Cash Flow |
|---|---|---|---|---|
|
Whole Foods |
$625 million |
$1,050 million |
$476 million |
$203 million |
|
Sprouts |
$78 million |
$282 million |
$144 million |
$131 million |
Data source: Yahoo! Finance. Net income and FCF reported on trailing twelve-month basis.
It should be noted that Whole Foods is valued at roughly three times the size of Sprouts. It's also important to point out that Whole Foods pays for its new-store expansions almost solely from free cash flow (FCF). If it used debt instead, its FCF would stand at $603 million.
Taking all these things into consideration, it's clear that Whole Foods is in the superior position. It only recently started taking on any debt at all, and that was largely because the money could be borrowed at such cheap rates. Sprouts, on the other hand, has a much higher debt load, relative to the amount of cash it has on hand.
Winner: Whole Foods.
Sustainable competitive advantage
Another name for a sustainable competitive advantage is a "moat." One of the reasons that every player in the organic industry has struggled lately -- and why organic goods can be had cheaper than ever before -- is that there are no significant moats for anyone in the industry.
As the popularity of natural and organic foods has increased, farmers have had more incentive to switch over to new farming practices. Because Whole Foods didn't -- and couldn't -- sign exclusive contracts with every potential organic producer worldwide before companies like Sprouts popped up, there weren't very high barriers to entry.
At the end of the day, organic-food shoppers are starting to look a lot like buyers of airline tickets -- there's very little brand loyalty, and price seems to be the most important variable. When that's the case, it's never good for industry players.
Winner: Tie.
Valuation
Finally, we need to evaluate how expensive each stock is. Just this past week, Sprouts announced that it was cutting its comps outlook for the third quarter. That sent its shares down over 15%, but it wasn't alone: Whole Foods shares dropped over 6% in concert.
Given these lower valuations, which stock is a better buy today? Let's look at four popular metrics: ratios of price to earnings, price to free cash flow, price to sales, and price/earnings to growth.
|
Company |
P/E |
P/FCF |
P/S |
PEG Ratio |
|---|---|---|---|---|
|
Whole Foods |
19 |
43 |
0/59 |
1.9 |
|
Sprouts |
21 |
19 |
0.75 |
1.6 |
Data sources: Yahoo! Finance, E*Trade, YCharts. P/E represents figures from non-GAAP earnings.
As I said above, Whole Foods' FCF is skewed because it uses the money to fund growth, instead of debt. If we back this out, shares of Whole Foods trade for a more reasonable 15 times FCF.
When we look at the more holistic picture, we see two companies that are pretty fairly valued. Sprouts is cheaper based on its PEG ratio and price-to-FCF. Whole Foods is cheaper based on price-to-earnings and price-to-sales.
Winner: Tie.
So, if you must choose between these two companies, I would argue that Whole Foods is the better bet today.
But in reality, you don't have to choose. And I would personally favor staying out of both companies. Whole Foods is staking its turnaround hopes on a smaller 365-branded store, but I think it, along with Sprouts, is in the unenviable position of running an extremely low-margin, commodity-based business. That's not a great environment for your hard-earned dollars.
