Shares of Whole Foods Market (NASDAQ: WFM) were dying on the vine once again this week. The nation's leading organic grocer turned in another lackluster earnings report late Wednesday, causing the stock to take a 10% dive.
The company reported a same-store sales increase of just 3.6%, below the average estimate of 5.3%, and revenue growth has declined to its slowest pace since the recession.
While 3.6% comparable sales growth would be solid for most supermarket chains, Whole Foods' stock is priced at a premium. But the company's once-strong growth has faded in recent quarters due to competition from Kroger, Wal-Mart (NYSE:WMT), and others, which have expanded their selections of organic foods and undercut Whole Foods on price.
To combat this slowing growth, management announced a bold initiative in its earnings release. The company will launch a separate chain of smaller, lower-priced grocery stores. Co-CEO Walter Robb called it a "new, uniquely branded store concept unlike anything that currently exists in the marketplace," adding that it would offer "industry-leading standards at value prices" and would be geared to millennial shoppers.
The company did not reveal many more details on the new venture, nor has it chosen a name for the new chain. Management said it is putting together a team to focus exclusively on the new concept and plans to open stores next year. It said it would provide details sometime "before Labor Day."
The market didn't seem to respond favorably to this news, based on the stock's sell-off, but this new business could provide exactly the growth Whole Foods is looking for. Here are a few reasons why.
Smaller is easier
Whole Foods isn't the only chain to look for growth in smaller-footprint stores. Walmart, which has dominated the retail landscape with its superstores, came up against the same problem as sales at its core format have flattened in recent years. With thousands of Walmart Supercenters nationwide, they may be reaching a saturation point.
To find further growth in the U.S., Walmart has begun opening up Neighborhood Markets. These are smaller, grocery-focused stores that average 42,000 square feet, or about a quarter the size of a Walmart superstore. Performance has been strong among Neighborhood Markets, as same-store sales jumped 7.7% in the most recently reported quarter. Walmart is growing the format quickly, having opened 233 of the smaller stores last year.
Whole Foods has just over 400 locations currently, and it believes the domestic market can support as many as 1,200 of its supermarkets. But it's harder to find real estate for larger stores, and smaller outlets are often a better fit in densely packed cities. Whole Foods stores average 38,000 square feet, about the size of Walmart's Neighborhood Markets.
Meanwhile, Trader Joe's stores average just around 10,000 square feet, with more than double the sales per square foot of Whole Foods. A smaller footprint should allow Whole Foods to increase its market penetration, especially in bigger cities, and could drive higher sales per square foot by eliminating some slower-selling segments and maximizing its real estate.
A lower price point will expand its market
Whole Foods Market offers a premium product at a premium price. A visit to one of its stores is a different experience from most supermarkets. Stores tend to be built with high ceilings and are filled with light. Produce is arranged in an eye-catching, colorful manner, and its prepared foods are plentiful and diverse.
The high prices that come with that type of product have earned Whole Foods the moniker "Whole Paycheck". Indeed, management has resisted competing on price, believing Whole Foods to be a premium brand. The company has made efforts to lower prices, but it's not going to win against companies like Walmart by competing on price.
A lower-priced chain will help it target those bargain-minded shoppers. Most importantly, it will allow Whole Foods to tap into the millennial generation, who are often looking for organic, local, and healthy products like the ones Whole Foods sells, but not at Whole Foods prices. Therefore, a new pared-down chain with lower prices is probably the best way for the company to reach millennials.
Co-CEO Robb said, "We believe the growth potential for this new and complementary brand to be as great as it is for our highly successful Whole Foods Market brand." The company is in the process of negotiating leases and expects expansion to be "fairly rapid" once it begins opening stores.
Whole Foods' current problems are a reflection of its success rather than failure. It pioneered the market for organic groceries, and its success attracted competition at a lower price. If the new chain can provide Whole Foods-like standards at a price millennials can stomach, it will surely reap a rich harvest.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Apple. The Motley Fool recommends Apple and Whole Foods Market. The Motley Fool owns shares of Apple and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.