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What Fairway's Bankruptcy Means For Whole Foods Market

By Jeremy Bowman - May 6, 2016 at 9:55AM

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Organic grocers continue to struggle. Is there any way out for Whole Foods?

It's been another ugly week for organic grocers. Sprouts Farmers Market (SFM -1.41%) is trading down 10% on slower-than-expected sales growth. Whole Foods Market (WFM) reported comparable sales down 3% on Wednesday, its worst result since the depths of the recession. And Fairway Market filed for bankruptcy, a fate that may best sum up the struggles of the organic industry.

From a fruit stand to no man's land
New York's beloved specialty market started from humble beginnings, and had only 11 stores when its private-equity owners took it public in 2013. Touting its unique position, with the features of specialty, organic, and conventional grocery markets, the company saw itself expanding to 300 stores nationwide. Instead, it only made it to 15 when it called in the creditors. 

Fairway was torched by a high debt burden and lack of profitability -- the usual formula for bankruptcy -- but competition helped undo it as well. Whole Foods and Trader Joe's invaded its turf, opening stores near existing locations, taking away precious traffic just when it needed it most.  Comparable sales plummeted and losses mounted. Fairway's stores will remain as it restructures its debt, but there are several lessons in its wake for Whole Foods and its ilk, as well as investors.

When high competition meets slow growth
The grocery industry doesn't lend itself to rapid growth. Demand for food and sundries is relatively fixed, meaning that competitors are fighting over market share rather than expanding the overall market the way that, say, a tech company might. For Fairway to expand from 11 stores to 300 would mean taking share from entrenched rivals in parts of the country where it was unknown. In a high-growth industry, that wouldn't be so difficult -- but when comps are falling and industry growth is flat, it's close to impossible.

Whole Foods finds itself in a similar predicament today. With about 450 stores nationwide, Whole Foods still sees room for 1,200 locations nationwide, nearly triple its current count. With the upcoming launch of the 365 chain, management believes the ceiling could be significantly more than 1,200.

Considering that rivals like Kroger (KR -0.35%) and Wal-Mart have more than double that number, it's not an unrealistic goal, but the company first needs to overcome its current challenges.

Whole Foods' sales growth has been decelerating for several quarters now, and the company has rolled out strategies to reverse it. It's implemented a digital coupon program for the first time ever, and it's lowered prices across the board, on average by 80 basis points. Thus far, however, such moves have not reversed the customer exodus, eating into profits -- gross margin was down by 103 basis points in its latest quarter -- without driving sales traffic. The company is making other moves as well, such as its partnership with Instacart and the new 365 stores, but shoring up what's inside the stores is most important.

Fairway was different, but also not
Whole Foods and Sprouts aren't about to turn into Fairway and declare bankruptcy. Both are still considerably profitable, with Sprouts growing comparable sales nearly 5% in its latest report, but the industry is only consolidating around them. Kroger, which always seems to be sniffing out its latest acquisition, snatched up Midwestern chain Roundy's last year, and fellow organic grocer The Fresh Market sought an acquisition from private equity group Apollo Global Management to turn around its plummeting sales growth. Meanwhile, Trader Joe's is expanding rapidly, and other competitors are on the move as well, including European grocer Aldi, which plans to open 650 stores. 

In its recent earnings call, Whole Foods again touted its differences from other supermarkets. For instance, the company sells only cage-free eggs, and is rated #1 for seafood sustainability by Greenpeace. But Fairway also claimed to be "like no other." For Whole Foods and Fairway, those differences just aren't enough. If they were, the chains wouldn't be seeing customers fleeing.

While Whole Foods' new 365 chain holds promise, the company has to find a way to return sales growth to its existing stores. As the Fairway's fortunes show, that won't be easy. 

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Stocks Mentioned

Whole Foods Market, Inc. Stock Quote
Whole Foods Market, Inc.
WFM
The Kroger Co. Stock Quote
The Kroger Co.
KR
$48.53 (-0.35%) $0.17
Sprouts Farmers Market, Inc. Stock Quote
Sprouts Farmers Market, Inc.
SFM
$25.50 (-1.41%) $0.36

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