Whole Foods Market Inc. Company Analysis

...

Profitability

WFM has managed to maintain constant costs to achieve profitable margins throughout its history. Over the past 15 years they have maintained an average gross margin ratio of 37.72% and have improved this to a recent three year average of 38.18%. In 2014, their COGS to sales ratio of 61.89% beat the industry average of 71.65%. SG&A costs to sales have been consistently decreasing to a low of 28.96% in 2014. A true testament to the management teams ability to operate efficiently. Their stable cost structure has enabled the firm to achieve impressive operating margin and net margin ratios of 9.15%, and 4.08% respectively in 2014. Even though these ratios may have slightly decreased in 2014 compared to 2013, they demonstrate the effectiveness of the firms pricing strategy. The retail food industry’s lower net profit margin average of 3.05% reinforces the strong profitable margins WFM has been able to sustain. The ROA and ROE ratios have continued to increase over the last five years to 10.08% and 15.18% respectively, while new store openings are at a pace of 30 per year. It appears that the management team is able to manage their cash more efficiently when compared to their ROA. Comparing it to the industry ROA average of an 8.28%, Whole Foods WFM clearly derives more value from their assets than their competition1.

Growth

Sales growth has remained positive over the past few years achieving an average of 11.16%. But there is a clear slowdown as sales growth has decreased from 15.74% in 2012 to 9.89% in 2014 as seen in table 1 below. WFM rates of growth in assets and net income mirrored this relationship too with a respective 23.35% and 35.89% in 2012 to 3.72% and 5.08% in 2014. This information illuminates the fact that the firm may have reached a market saturation point in highly priced organic foods. Additionally, the decrease in sales growth has translated to a low EPS of 6.08%. This does bring into question the extent to which management has to ultimately lower company-specific prices to be more competitive in the marketplace. The management team has confirmed that they plan on rolling out a new low cost alternative store called 3651. This would explain the CEO’s aggressive target to reach 1,200 locations considering that their firm is experiencing a decelerated growth. The firm’s ability to keep growing is largely dependent on their new brand of stores, expansion in their existing markets and pricing.

Table 1 Growth Ratios for Whole Foods Market: 2010 - 2014

2010

2011

2012

2013

2014

*Industry

Sales Growth

12.13%

12.24%

15.74%

10.41%

9.89%

7.42%

Asset Growth

5.37%

7.66%

23.35%

4.60%

3.72%

6.37%

Net Income Growth

67.46%

39.37%

35.89%

18.35%

5.08%

16.39%

Earnings Per Share

70.59%

35.17%

30.10%

-41.96%

6.08%

10.44%

Source: WRDS

*The industry ratios are derived by averaging 2014 growth ratios for the Kroger Company, Wal-mart, Publix Super Markets, Fresh Market, Sprouts Farmers Market & Daelhaize

Valuation

WFM may potentially be undervalued. WFM’s P/E ratio dipped to a new low of 24.27 in 2014. This is well above their P/B ratio of 3.60 illustrating that their perceived value is still higher than their actual book value. But their P/B ratio is well below the industry average of 5.63 reinforcing the idea that it is being neglected. Even their current trailing P/E ratio of 20.64 is lower than the current S&P 500 P/E ratio of 22.10 showing that the company may be undervalued2. This reflects investor’s future expectation of growth for WFM. Furthermore, dividend payouts over four years are up 223% at $170M and share repurchases are up 1,920% in FY2014. It is clear that the shareholders continue to be an important part of the WFM financial strategy with such strong dividend payments and focus on driving up their share price. Additionally, a return on free cash flow to equity was calculated at 102% emphasizing the abundant capital that is available to the shareholders1. Clearly, WFM is a profitable company generating cash but the market does not currently share that sense of optimism.

Working Capital

WFM’s management team maintains an efficient cash flow management with a working capital surplus. Their 2014 current assets were 28% larger than their current liabilities. WFM has an average day sales outstanding ratio of 5.20 and a day’s payable outstanding ratio average of 11.40 meaning that they are getting paid before their bills are due. Their average ITO of 19.57 reflects that their cash is not tied up in inventory too long; however, this rate is not only higher than the industry average but has been consistently increasing since 2009. This correlates with the decelerated growth assumption, as a decrease in sales would lead to an increase in the inventory rate because goods would be sitting longer. The TAT ratio has shown a steady increase over the past five years to a 2.47 and has been one of the main drivers that increase the value of the DuPont Analysis in addition to profitably1. The management team has successfully generated revenue from its assets putting the firm in an excellent cash position. But this will