By most measures, Whole Foods Market (NASDAQ:WFM) has enjoyed another laudable year as the most visible pioneer in the natural and organic retail grocery space. The company's most recent quarterly net profit margin, at 4.07%, is nearly seven times the average industry net profit margin of 0.6%.Whole Foods enlarged its store count by 8% in the fiscal year ended Sept. 29 and increased average weekly store sales to an impressive $711,000 per store. The company has a pristine balance sheet, with almost non-existent long-term debt.Finally, Whole Foods stock kept even with the broader market in 2013, posting a total return of more than 28% year to date.
But 2013 was also a year in which Whole Foods seemed to grapple with a future in which critical mass will be reached, and an inevitable slowing of its phenomenal growth rate will occur. Comparable-store sales increases for the fiscal year departed from the heady 8%-plus rates of 2012 and 2011 and returned to 2010 levels, at 6.9%.That the company's stock did not outpace the S&P 500's year-to-date total return of more than 29% reflects investors' reassessment of the stock's near-term prospects. As Whole Foods closes out the first quarter of fiscal 2014 and we head into a new calendar year, what changes might we see in the company's corporate strategy designed to maintain its outperformance?
Whole Foods may roll out its long anticipated loyalty program
In November, Bloomberg News reported that Whole Foods was in the process of testing a loyalty program, which would extend a discount of 10% on its private-label, "365" brand items.While investors have anticipated such a program for some time, 2014 may be the year we actually see it implemented.
Creating a loyalty program is a logical step for Whole Foods, as it opens a means to increased total customer visits. By discounting the 365 line of groceries, which includes many staples, the company can entice the customer who typically shops for only a few recurring items to switch to Whole Foods for weekly groceries. Each additional item in a weekly customer's shopping cart creates an offset to the margin lost in the incentivized (discounted) items.
For a higher-end chain, a loyalty program is almost more valuable as a method to increase traffic than as a retention strategy for current customers. But will a discount program lower the premium perception that surrounds Whole Foods and turn off current customers? Probably not. The North Carolina-based Harris Teeter grocery chain, which was acquired by Kroger (NYSE:KR) this past August, provides an example of an upscale grocer that successfully implemented a loyalty program. At the time of acquisition, Harris Teeter's loyalty program had a favorable view among its customer base that was 15 percentage points higher than the sentiment Kroger's customers held for its loyalty program, according to analytics firm DataRank.
A debt issuance in 2014?
The past few years of Whole Foods' expansion have been almost totally self-financed,with the company using its strong operating cash flow to open new stores. However, with management recently expressing a desire to increase store count at a more aggressive pace in coming years, the company may be thinking about adding a reasonable amount of long-term debt to its books in the near future. This is because Whole Foods already allocates nearly 50% of its $1 billion annual operating cash flow to supplying common stock dividends to shareholders. In fiscal 2013, the company paid out $508 million of dividends and incurred fixed asset purchases of $198 million, along with $339 million of development costs for new locations.Thus, between returning cash to shareholders and adding new locations while maintaining current fixed assets, Whole Foods is near current capacity to self-fund further expansion. With the Federal Reserve already beginning to taper its monthly bond purchases, management may be even more willing to take on a bit of added long-term debt while the interest-rate environment is relatively favorable. You can be pretty sure that any debt issuance will be at a manageable level, in line with the the company's recent prudent balance sheet management.
Slightly smaller stores with a high return
One of the areas in which Whole Foods exhibits admirable discipline is its ability to keep average store size at a desired level, despite a mix of store sizes in both urban and suburban markets. Since 2010, the company has maintained an aggregate average store size of 38,000 square feet.This appears to be an optimal average store size for Whole Foods, which, as I have written about previously, allows the company to maximize what it believes to be its most important metric: return on invested capital. However, it's entirely possible that this average store size may actually decrease, if only by a couple of thousand square feet per store, over the next several years. Whole Foods is beginning to penetrate smaller suburban markets, some of which have populations as small 200,000 to 250,000. Smaller stores in more diminutive markets may be the key for the grocer to reach its recently revised long-term goal of opening 1,200 stores. Shrinking retail footprints come with another advantage: they lend themselves to higher sales per square foot, which is another metric closely watched by Whole Foods' management, and its investors as well.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors.
Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.