Whole Foods Market (NASDAQ:WFM) touts itself as "America's healthiest grocery store" with its offerings of organic and minimally processed natural groceries. Despite being a pioneer in organic retail, the chain is facing tough competition as smaller players like Trader Joe's and Sprouts Farmers Market are upping their game, and big retailers like Wal-Mart, Kroger, and Costco are increasingly stocking organic fare. To take up the challenge, Whole Foods is chalking out ambitious expansion plans and spending millions on them. Is the company being foolhardy? In the face of slowing same-store sales growth, is there room to grow for the specialty retailer?
Management's putting thoughts into action
On the fourth-quarter earnings call, co-Chief Executive Officer Walter Robb made some bold remarks. He said, "As we accelerate our growth, we are evolving and differentiating our shopping experience faster than ever before. Our leadership in retail innovation is one of our many competitive advantages, and it is exciting to see our new stores from Palm Desert, California to Toronto perform so well."
And it's not just talk. Whole Foods spent $710 million on capital expenditure in the fiscal year ended September 2014. The company opened a record 38 new stores during the fiscal year, of which 55% were in new markets. The year-end tally stood at 399 stores with 15 million square feet of retail space.
And this is just the beginning. Whole Foods plans to add another 38-42 new stores in fiscal year 2015 with 9%-10% square footage growth. Management has its eyes set on growing its store base to 500 by 2017. In the long run, Whole Foods has said the store count could go up to 1,200 in just the domestic market. The company plans to refresh 70% of its old stores operating for more than a decade. Whole Foods believes that the store upgrades will give an immediate sales boost at the store level, while overall comps will start showing results from fiscal year 2016.
Whole Foods is bringing plenty of innovation to its stores. For instance, the Post Oak store in Houston that opened on Nov. 6 has the company's first brewpub -- Whole Foods Market Brewing Company -- with a choice of 20 beers on tap, exclusive food pairings, and lounge seating, among other things. The store will also feature a barbeque bar, a juice bar, and lifestyle area with clothes and accessories.
There could be more to this than what meets the eye
In fiscal year 2014, Whole Foods' revenue touched a record $14.2 billion, but comps growth was lower at 4.3% compared with the 6.9% recorded last year. So, lifting comps and warding off competition may be the immediate motives, but it's quite possible that the company's investments are also because of a widening market that can accommodate multiple players profitably.
The organic food market, which came into existence in the 1970s, has grown at an exponential rate over the last three decades. Though the growth rate slowed in the aftermath of the recession, sales have recovered in the recent past. In 2013, organic sales grew 11.5% to $35 billion, according to the Organic Trade Association. Specialty retailers like Whole Foods command around 44% of this market as per the 2012 estimates of Nutrition Business Journal. The journal forecasts the organic food market to grow to $60 billion by 2020.
"There's a growing belief among a lot of educated people, and it's filtering into the mainstream, that organic is a better way to eat," Jim Hertel, managing partner for retail consultancy Willard Bishop, told Bloomberg Businessweek.
Most farmers find it difficult to transition from conventional methods to organic farming, which limits supply and caps the industry's growth prospects. The U.S. Department of Agriculture is trying to help farmers by providing more resources that will aid growth. Thanks to the government's efforts, the number of certified organic farms and businesses in the country increased to 18,513 by 2013, up 245% from the 2002 levels. The growth trajectory could continue as the 2014 Farm Bill has several funding provisions to support the organic community. This creates a huge opportunity for Whole Foods.
New initiatives could create more value for investors
Whole Foods has had a good track record of generating strong returns on invested capital. In the last eight quarters, new stores less than 2 years old on an average have registered 83% productivity and generated $503,000 weekly sales translating into $722 sales per square foot. This has resulted in 15% return on invested capital for these stores, above the weighted average cost of capital of 10.82%. The chart below provides a snapshot of the comps and ROIC of the different stores during 2014 fiscal year.
The Foolish conclusion
Whole Foods once turned a niche business into a money-spinner. With the changing times, the company is trying to reinvent itself while keeping its core values intact, which is not an easy task. It has taken a bold step of growing its footprint. The organics industry's enormous prospects could take the company to the next level, once Whole Foods gets things right.