After examining the lower half of the supermarket sector, I recently recommended sticking with Kroger (NYSE: KR), which is a known quantity, and which is performing better than companies like Roundy's (NYSE: RNDY). Now let's take a look at the upper half of the market, where companies that investors are actually excited about reside. These aren't the grocery stores of my youth, and in fact most operate much more like the grocery stores of my grandmother's youth. Higher prices, but more care put into product selection and customer service. These are the new-wave grocers, putting everyone else on the back foot.
The main players
It's simply not possible to talk about organic food without giving a nod to Whole Foods (Nasdaq: WFM). The company has helped make "organic" a household term, and has made heaps of cash at the same time. Of course, being that popular doesn't come without some baggage. Consumers are drawing lines in the sand, with organic saber rattlers on one side and low-price advocates on the other. In a lot of ways, Whole Foods has become the standard bearer for the organic movement.
Its place in the sun is paying off, too. Last quarter, Whole Foods reported a 14% increase in revenue, and an 8% increase in same store sales. Compare that to one of the bottom dwellers in the grocery space: Roundy's turned in a 2% increase in revenue, while same-store sales dropped 3%. But Roundy's probably isn't going to create the same sort of consumer divisiveness that Whole Foods seems to generate. Part of that comes from the brand's luxury perception, which allows it to post strong margins, and which lets customers treat it as an aspirational brand.
We'll get back to margins in a second, but first let's look at another company playing the Whole Foods game. The Fresh Market (Nasdaq: TFM) has, arguably, done an even better job of being perceived as an aspirational brand. With similar growth figures, including 8% same-store sales growth last quarter, The Fresh Market is taking aim at a segment that Whole Foods currently dominates. To differentiate itself, The Fresh Market pumps in classical music and lays out its stores with low shelving units.
The margin payoff
All the work that both companies put into attracting high-end customers pays off in their operating margins. Both Whole Foods and The Fresh Market had operating margins of 7% last quarter, while market stalwart Kroger came in at only 2.5%. That 7% margin means that as commodity prices fluctuate, Whole Foods and The Fresh Market will either be able to absorb extra costs instead of passing them on to consumers or they will be able to pass on small changes to their less-price-sensitive shoppers.
Kroger and Roundy's are fighting for cost-conscious customers, so small shifts in product costs can drive customers away. That could be especially dangerous this year, as corn, wheat, and other grains are facing worldwide supply issues. The last quarter for all of these grocery chains could be an excellent indicator of how they handle commodity pressure -- a pressure that all grocery chains are more likely to face in the future.
Winning the food fight
While neither Whole Foods nor The Fresh Market can be considered cheap stocks, they both offer investors expansion that traditional grocers are lacking. I like Kroger, and it just announced a 30% increase in its dividend, which long-term investors should be very happy to hear. Whole Foods pays a small dividend, which should grow if the company can get closer to its 1,000-store goal. That push is currently a drain on resources, and with only a little more than 300 stores right now, it might be a while before those funds get freed up. The Fresh Market is even closer to its infancy, and expansion is taking all of the company's available resources. It is not paying a dividend at all.
It's hard for me to pick a clear winner here. I like the stability of Kroger, the brand and strength that Whole Foods has displayed, and the growth potential that The Fresh Market has. Looking at price, Kroger is the clear safe bet, with a P/E under 10. Whole Foods and The Fresh Market are both over 30, which is a reflection of that growth potential.
Depending on your own portfolio goals and diversity, I think you can comfortably pick up any one of these three as a welcome addition. All of them offer something to investors, and each presents its own risks. To follow the expansion of Whole Foods, sign up for the Fool's special report on the company. It comes with a year worth of free updates, and gives you specific information about what's going right and what investors need to look out for. Fool readers can click here for your copy today.
