Whole Foods Market (WFM) has entered 2014 with much of its typical momentum, yet its forward guidance is fraught with uncertainty. During last week's conference call with analysts, management tried to explain its ambivalence regarding the company's revenue prospects. On one hand, the outlook has never been better, as Whole Foods has a record 107 stores in its development pipeline.
And yet co-CEO John Mackey was frank when asked about the recent trend of comparable-store sales growth. Mackey communicated that comparables have declined because of a number of factors, implying that there is no single point of execution available for a quick fix. While Whole Foods reported a brisk 5.4% comparable-store sales increase for the quarter, this mark falls below the baseline of roughly 7%, which the company has come to think of as a long-term benchmark. Management cited the inclement weather, which has plagued the country this winter, while acknowledging that competitive pressures may also be hindering sales increases. It also offered that some short-term cannibalization is likely occurring in urban markets such as Boston, where Whole Foods has opened multiple locations in close proximity.
As a tactic to shore up revenue growth, it's possible that we may see Whole Foods shift its emphasis somewhat in the near term to its new store pipeline. Accelerating stores in development may be a relatively painless way to ensure that the company's long-term growth story remains intact.
Below is a table of Whole Foods' store count at the end of the first quarter during each of the last four years, as well as the number of stores in the company's development pipeline. Whole Foods counts a store as part of its development pipeline when it has signed a building lease (or ground lease when the company will build its own structure).
It took Whole Foods 30 years to reach the 289-store mark, in quarter one of 2010. But in the last four years, the company has added nearly a third more stores. Both the growth rate of new stores under development and growth rate of total stores have picked up aggressively over this period.
The development pipeline is also growing in relation to existing stores, as can be seen in the table. In 2010, the pipeline of stores was equal to 17.6% of the company's total base. In 2014, the pipeline relative to total stores now is equal to 28.6% of operating locations. A larger pipeline relative to existing stores gives management more flexibility when it projects financial performance. Management can look two to four years ahead and either accelerate or diminish the pace of new square footage as it sees fit to meet revenue goals.
If Whole Foods shifts its emphasis, will this affect profit?
Should Whole Foods choose to speed up the introduction of new retail square footage, it will have to keep a tight rein on costs. The company has excelled in recent years in controlling pre-opening expenses. Five years ago, in fiscal year 2009, Whole Foods spent $3 million in pre-opening expenses, including rent, for each new store. By fiscal year 2013, it had decreased this average expense by nearly 50% to $1.7 million per store. Management will need to continue its high performance regardless of its new store opening pace. Current investments in price throughout the Whole Foods store base (discounting to gain new customers) will leave little room for the development team to err as it handles an ever-increasing number of store openings each year.
Another metric related to profit that may be affected if new store openings climb is the company's return on invested capital, or ROIC. As I've discussed previously, management may decide to incur a modest amount of debt in 2014. This will become more likely should management choose to shift to a faster store opening schedule. New debt combined with higher fixed asset depreciation numbers (a function of a recent trend toward larger stores) may stall or slightly decrease the company's current ROIC of 13.3%. However, over the long run, the investment in new stores should equalize ROIC and eventually send it higher.
Whole Foods' potential market keeps expanding
At a current count of 373 stores, Whole Foods keeps finding new opportunities to branch out, in part because its target demographics keep expanding. David Lannon, executive vice president of operations, mentioned on the earnings call the encouraging first week sales of a new store in Jackson, Miss., "a place we never thought we'd have a store 10 years ago." With each passing year, the grocery category of natural and organic foods continues to race ahead and create market opportunity. For Whole Foods, which just expanded its total potential opportunity from 1,000 stores in the U.S. to 1,200 based on a study of metropolitan markets, ramping up on those glistening new locations may be the best course of action.