"Whole Foods Is Getting Its Organic Lunch Eaten"

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The beginning investor could be forgiven for thinking that Whole Foods Market's (NASDAQ:WFM) business was drying up and that it's preparing to file bankruptcy, based on last week's headlines. While nothing could be further from the truth, the company's earnings report did contain more than a few disheartening tidbits for investors -- causing the company's stock to drop by as much as 20%.

Simply put: Investors are worried that Whole Foods is damned if they do, and damned if they don't -- especially when it comes to competition. Should the company lower prices on its goods, it would compete with Kroger (NYSE:KR) and Wal-Mart (NYSE:WMT) on price, but could lose what makes it distinctive. On the other hand, if Whole Foods doesn't lower prices, it could retain its differentiation, but new customers will continue to migrate toward other grocers in the quickly crowding organic/natural food space.

Indeed, there was a lot of "bad news" to digest from the company's latest earnings report: missing expectations on revenue and profit, while lowering forecasts for the rest of the year. But as I intend to show below, Whole Foods still has its best days in front of it, and I plan on putting my money on that sentiment.

Lowering prices won't ruin the brand
If there's one thing anyone who's shopped at Whole Foods knows, it's that going there is just as much about the experience as it is about getting food. That probably sounds obnoxiously snooty, but it's an easily demonstrated fact -- and it has helped the company grow to where it is today.

That's going to be an incredibly important differentiator moving forward, as Wal-Mart, Kroger, and Safeway come out with lower-cost organics, and The Fresh Market (UNKNOWN:TFM.DL), Sprouts Farmers Market, and Natural Grocers by Vitamin Cottage (NYSE:NGVC) double down on the strength of the organic movement.

To get an idea for just how far ahead of the competition Whole Foods is, take a look at how different the average employee's experience is at Whole Foods, as compared to the rest of the competition, according to reviews submitted to Glassdoor.com.

Source: Glassdoor. Kroger CEO did not have any current reviews.

I consider these employee opinions to be a fair proxy for the overall culture and vibe at a grocery store. If, as a shopper, I have the choice of going to Kroger or Whole Foods -- which both have organic goods for about the same price -- there's no doubt I'd rather spend my time at Whole Foods.

The fact of the matter is, if Whole Foods truly is reducing prices, it will take time for that message to filter down to the customers, meaning that while traffic might not pick up in the near term, it will over the long haul. As long as "lowering prices" doesn't mean "lowering the bar on customer experience," the drag between point A and point B here is the zone of opportunity for investors.

Easily the best player in the industry
But Whole Foods is also more than just a feel-good, hippie, fun-to-visit location. It is also a seriously successful capitalist organization. By almost any given metric, the company is heads and shoulders above the competition.

Source: SEC filings for FY 2013. Wal-Mart not included as it sells far more than just groceries.

The fact that Whole Foods is so far ahead of traditional grocers should be no surprise. But the difference between Whole Foods and the trio of upstarts -- Sprouts, Fresh Market, and Natural Grocers -- is important.

All three of these natural/organic-focused players have significantly smaller store sizes than a typical Whole Foods. That means that if I'm a health-conscious shopper, there's a much better chance that Whole Foods could meet all of my needs than if I went to Sprouts, Fresh Market, or Natural Grocers. And yet, that larger size doesn't mean that Whole Foods is less profitable -- in fact, it's almost three times more profitable than the next largest competitor.

This isn't about wealth, it's about education
For well over a decade now, Whole Foods has been trying to shed itself of the "Whole Paycheck" moniker. Many pessimists now believe that since Whole Foods has expanded to as many wealthy, urban locations as it can, new stores simply won't draw as many visitors as they once had.

But those pessimists are confusing a wealthy clientele with an educated one. The link between these two variables is strong, but it isn't absolute. As one real estate developer who has worked with Whole Foods recently wrote :

Unlike the typical retailer, and contrary to what you might expect, Whole Foods does not focus on household income but rather on education levels in a potential trade area. They usually require a minimum population of 200,000 with college educations. One of their brokers once told me, "Look, I don't care what the incomes are; show me there are enough people there with degrees." If you work at a nonprofit, a yoga studio, or in government, but still shop at Whole Foods, then you know that the Whole Foods customer is not defined by his or her salary. 

The key difference here, over the long run, is that this reduces Whole Foods' ceiling. If the company's growth were predicated solely on being able to attract more and more wealthy shoppers, it would end up being a zero-sum game: every dollar that one wealthy person has is another that a poorer person doesn't have. There can only be so many wealthy folks in America.

But wealth isn't the currency that Whole Foods trades on; education is. And unlike wealth, education isn't a zero-sum game. One student getting a college degree doesn't prevent another student from getting one, it just creates incentive for universities to grow -- or new schools to open. The point is: Whole Foods benefits from a more educated populace, and the move toward a more educated populace is a strong trend in America right now. The ceiling for the company is much higher with this education focus.

Why now is the right time to expand
Finally, some have suggested that Whole Foods' decision to vastly ramp up the opening of new stores is a sign of desperation. There's some truth to that sentiment, but it doesn't tell the whole story.

Historically, Whole Foods has taken the slow and steady pace to opening new locations. Not only did this allow the company to be sure that their stores were placed in the right neighborhoods, but it allowed them to expand without taking on debt, and without serious dings to the company's profits.

But the landscape has changed. While lower prices will help Whole Foods fend off Wal-Mart, Safeway, and Kroger, I believe Whole Foods' expansion plan has more to do with the upstart organic grocers that have broad ambitions.

Before these players let their expansion plans be known, nothing was forcing Whole Foods to expand at a quicker pace. But that time has now come, as Sprouts says it envisions 1,200 stores nationwide, Natural Grocers thinks there are 1,100 possible locations out there, and The Fresh Market believes it will one day preside over 500 locations.

But all of these companies have much smaller footprints, much less cash, and a debt load much higher -- relatively speaking -- than Whole Foods. What does this mean? Basically, that Whole Foods has the experience and balance sheet to be the first-mover in just about any market it wants -- and it intends on doing just that.

I'm all in
It's entirely possible that we're not done seeing the run on Whole Foods' stock. It could very well continue to fall in the coming months. But over the next decade, I have little doubt that today's price will look like a bargain in hindsight.

That's why I'm buying enough shares of Whole Foods -- once Motley Fool trading rules allow -- to bring the company up to a full 6% of my family's retirement fund.