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The business outlook at natural and organic foods grocer Whole Foods Market, Inc. (WFM) appears cloudy. While the company continues to grow sales, posting a 6% year-over-year jump in the September quarter, much of the growth is coming from newly opened stores. In fact, same-store sales declined slightly in the period, while share net was a nickel below the prior-year tally. Competition remains fierce, with new entrants in the organic and natural foods markets hurting WFM’s results. Bad publicity has also been a factor. As a result, the company’s stock price has fallen for much of the year, going from a high of nearly $58 early in fiscal 2015 to its current level of around $30.

However, this could provide a good entry point for value-oriented investors. While sales growth for the year is expected to slow to between 3% and 5%, and margins will likely narrow slightly, management is focused on improving business prospects. It is introducing new, value-focused stores, 365 by Whole Foods Market, later in fiscal 2016. It has also identified SG&A savings that it can take. However, overall costs will likely remain elevated, owing to the cost of initiatives to drive traffic, as well as store expansion expenses.

The question investors should ask is whether management will be able to improve business prospects given the mounting competition in the industry. Another question is whether the stock is a good long-term play. We will address these issues by performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.

The Business

Whole Foods Market is the largest natural and organic foods supermarket in the United States. It was the first national “Certified Organic” grocer, and to this day remains the only national supermarket with all of its stores and operations certified. The company’s mission is to set the standards of excellence in food retailing. As of the close of fiscal 2015 (ended September 27th), WFM operated 431 stores in the U.S., Canada, and the United Kingdom, averaging over eight million customer visits each week. It offers more than 25,000 unique organic products, including produce, dairy, meat, frozen, prepared foods, wine, cheese, vitamins, nutritional supplements, and pet foods, to name a few. The company has one operating segment, natural and organic foods supermarkets, and has roughly 61,700 full-time employees.  Stores average about 39,000 square feet. Nearly 97% of fiscal 2015 sales were generated in the U.S. Whole foods was incorporated in 1978, with its first store opening in 1980. It completed its IPO in January 1992, and trades on the NASDAQ.

Strengths

Highest Quality Standards: As we mentioned above, Whole Foods believes that its high quality standards set it apart from other supermarkets. This allows it to attract and maintain a broad base of loyal customers who return often. Its standards ban hundreds of ingredients commonly found in other supermarkets. These include no artificial flavors, colors, sweeteners, hydrogenated fats, or meat from animals raised with antibiotics. It also only sells eggs from cage-free hens, and bans numerous manufacturing, farming, fishing, and ranching practices that don’t measure up to its standards. While other grocery stores offer cheaper products, the quality of these items is typically below that of Whole Foods’ goods. Whole Foods has had the ability to offer higher-quality products at higher prices because the company is able to attract customers who are willing to pay a premium for better quality food. Many of these customers are better-educated, with higher median incomes, and are willing to pay a little extra.

Favorable Industry Trends: Whole Foods will likely continue to benefit from several trends in the food market industry. Over the past few years, there has been heightened awareness of the role that healthy eating plays in long-term wellness. As a result, the company’s offerings of natural and organic products ought to continue to sell well and support earnings growth. WFM continues to benefit from a highly influential younger generation that values not only health, but also sustainability of food and ethical trade. These consumers are also concerned about where and how food is produced, as well as environmental concerns.  These are all issues that Whole Foods takes very seriously. As the strongest brand in the natural and organic market industry, WFM should continue to make gains among the health conscious who want to fuel their bodies with the most natural and pure ingredients possible.

Weaknesses

Consumer Perception: While Whole Foods certainly has a big fan base among higher income, health-conscious consumers, there are also many individuals who think the company’s prices are very high. The company even has a nickname, “Whole Paycheck”, because of the perception that its products are quite high and can take up a customer’s “whole” paycheck. While the company’s prices are, on average, higher than many of its competitors, quality is also higher, so you’re getting something for the premium. However, it has been hard for the company to shake this image among lower and medium income households. As a result, many of these consumers have stayed away. The company is making plans to address these concerns, as we will discuss in the “Opportunities” section below.

Dependence on the American market: As we mentioned, in fiscal 2015, the United States accounted for roughly 97% of 2015 revenues for the company. This dependence on the U.S. market makes it vulnerable to downturns in its economy. During the most recent U.S. recession, Whole Foods posted a drop in profits, and this could very well happen during the next downturn. Thus far, the only other markets for the company are Canada and the U.K., and there are very few locations in those countries.

Opportunities

365 by Whole Foods Market: A few months ago, the company announced that it plans to launch a second store format, 365 by Whole Foods Market. The mission of this brand is to bring fresh, healthy, and affordable food to more people in more places every day. The offshoot expects to target millennials with lower prices on natural and organic products. These stores will likely be a bit smaller, with a more streamlined focus. Management hopes this segment will complement existing Whole Foods stores, allowing the company to address some of the concerns that its products are too expensive. If the strategy proves successful, by attracting more price-conscious consumers, it should support strong sales and earnings growth in the years to come. The company plans to open three 365 stores in fiscal 2016, with a bigger rollout the following year. Ultimately, it believes this brand, along with the traditional stores, will allow it to expand its growth opportunity to beyond 1,200 stores in the U.S.

International Expansion: Since 97% of Whole Foods’ sales came from the U.S. in fiscal 2015, we think the company has room to grow internationally. We look for the company to continue to expand its store base in Canada. This country, like the U.S., has a growing proportion of its population that is interested in natural, organic products. Management expects to increase the number of stores from the current 10 to more than 30 in the coming quarters. The company, which has been operating in Canada for more than a dozen years, could get a needed boost from its Canadian operations since same-store sales in the U.S. have been somewhat soft. If the company continues to boost its presence in both Canada, and possibly the U.K., this could support margin growth, as these limited locations have higher margins than the corporate average. While there are no plans to expand to other countries at the current time, this could be another big avenue for growth in the years to come. 

Threats

Competition:  Whole Foods faces intense competition in its industry, including from local, national, and international supermarkets, natural food stores, warehouse membership clubs, online retailers, farmers markets, and restaurants. Some of these are expanding more aggressively in the natural and organic foods markets. Costco (COST) has been expanding its organic offerings, and can offer them at lower prices than at WFM. Other competitors include Sprouts Farmers Market (SPM), which is also focused on selling fresh, organic, and natural products, and Trader Joe’s, a privately held business that has a reputation for offering inexpensive natural products. As Wal-Mart (WMT Free Wal-Mart Stock Report), Kroger (KR) and other companies begin to offer more natural and organic products on their shelves, at lower prices, this will only continue to pressure results at Whole Foods, particularly given its higher price points. Whole Foods needs to shed its “whole paycheck” image before it’s too late.

Negative Publicity: Aside from the negative publicity about the company’s products being too expensive, Whole Foods has also faced some other challenges. Earlier this summer, the company was accused of overcharging customers. The New York City Department of Consumer Affairs said the chain was overstating the weight of some pre-packaged goods. While the company has taken steps to prevent overcharging customers going forward, including retraining certain workers and a pledge to give away products if customers discover they were overcharged, the outcome nevertheless hurt the company’s perception, and hurt results for the June quarter. Future missteps on the publicity front could be even more costly.

Conclusion

Whole Foods has maintained its image of providing the very best natural and organic products. However, given industry trends showing a more health-conscious U.S. population, other grocers and companies have jumped on the natural foods bandwagon. This has caused problems at WFM, particularly given its higher prices. To help combat these concerns, the company has initiated its first national brand campaign and will introduce its lower cost stores later in the year. Management looks for 2016 sales growth of between 3% and 5%, with 30 new store openings. However, margins are expected to narrow, and share net is expected to come in slightly lower than the 2015 figure.

Value investors looking for an entry point could find an opportunity here, assuming the stock is close to bottoming out given some of the negative news and soft same-store sales figures of recent months. In fact, the stock is at its lowest point since 2011. However, this assumes the company’s plans to improve same-store sales and earnings come to fruition sooner rather than later. It also must address the “whole paycheck” stigma as soon as possible. The stock likely has good long-term appeal, as it should benefit from favorable industry trends and an expanding store base. But this also assumes that the grocer takes the right steps to battle fierce competition. Subscribers interested in learning more about Whole Foods should check out our full-page report in The Value Line Investment Survey.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.