Whole Foods' Other Problem

Whole Foods Market, Inc. is a fast growing natural and organic foods retailer, riding the healthy food craze, which has allowed the company to charge premium prices for its products, compared to conventional products.

The trouble is this: Whole Foods Market doesn’t own the organic farms that produce the products it sells at its stores. It buys those products from others.

So do scores of other retailers, who have been expanding their presence in the market for natural and organic food, and competing with Whole Foods Market on both fronts — the resource market, where the company buys organic food; and the commodity market, where it sells it.

That’s just one of Whole Foods’s problems.

The other problem — more severe in our opinion — is that the company is running out of affluent neighborhoods to sell its produce in.

That’s market saturation, which slows down sales growth, intensifies pricing pressures, and compresses profit margins.

Whole Foods Key Metrics

Metric	Forward PE	Operating Margin (%)	Qtrly Revenue Growth (%)	Qtrly Earnings Growth (%)
	22.01	6.56	10.20	5.70%

Source: finance.yahoo.com

Here is a quote from the last conference call. “In Q2, our sales increased 10 percent to $3.6 billion driven by comps of 3.6 percent and square footage growth of 11 percent. We opened 11 new stores, including three relocations and three former Dominick’s locations. There are many moving pieces, so we can’t say definitively what caused the moderation in comps during the quarter. We do know that we are not immune to the larger macro environment, and the exploding demand for natural and organic products has resulted in increased competition from many different channels. In addition, severe weather and cannibalization had a larger impact in Q2 than in Q1.”

And a previous call. “Our 3.9 percent comp increase reflects continued headwinds from our value efforts, cannibalization, competition and the economy. Our comp increase was driven by approximately equal increases in transaction count and basket size. Our average price per item growth was approximately 2 percent. We continue to see signs of trading up, and inflation remains a factor. On the cost side, we saw spikes in some categories; however, our overall cost increase was in line with last quarter. Reflecting our ongoing value efforts, this was the 10th consecutive quarter in which our retail price increases were less than our cost increases. Our value efforts were also reflected in our gross margin results. The 31 basis point decrease from our record 36.6 percent result last year was driven primarily by an increase in cost of goods sold as a percentage of sales.”

And Gross margins, excluding the non-routine supplier credit, declined, again, by 12 basis points due primarily to higher cost of goods sold as a percentage of sales.

Whole Foods Market  is finding out the hard way that not all consumers are equal in terms of income, even if they have the same preferences. They’re also learning thatprice does matter, even for organic food fads, when income is not there.

That’s especially the case for the health cautious Millennials. That’s why the company is opening separate stores to address this market.

Will this strategy work, or just cannibalize the company’s existing stores? It remains to be seen.