Whole Foods: The Best Growth Is Yet To Come

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Whole Foods (NASDAQ: WFM) is one of the largest (and most profitable) chains of grocery stores in the U.S.  Over the past decade, the company has done a very impressive job of growing revenues (see below), including and especially during the tumultuous 2008-2010 period, when it seemed like every company was selling less.  With a double-digit projected growth rate, great balance sheet, and a nice growth strategy, Whole Foods may have even brighter days ahead.

Established in 1980, Whole Foods has grown into the largest chain of natural and organic food retailers in the country.  There is still significant room for growth, as the company currently has just over 335 stores in 37 states, Washington, D.C., Canada, and the U.K.  Catering to health-conscious consumers has proven a very wise strategy, as the company has had very nice same-store sales growth (around 7.5%).

The company’s growth strategy is to seek new locations for its stores in highly populated, often urban, areas.  Each store averages around 38,000 square feet, and about 30% of the company’s stores were acquired, meaning that they were other health-food stores that were bought out and re-branded as Whole Foods. 

One of the most significant differences from traditional grocery stores is the company’s emphasis on perishable foods, which account for about two-thirds of the company’s sales.  This also causes customers to shop more frequently in order to get fresh groceries, which also helps revenues. 

Whole Foods trades at a premium valuation right now, but don’t let that dissuade you from considering an investment.  The stock currently trades at 38 times 2012’s earnings of $2.52 per share, which are expected to grow to $2.89, $3.43, and $4.11 over the next three years, or a 17.7% annual average earnings growth, which justifies the high valuation.

Additionally, Whole Foods has a positive net cash position of about $7 per share, and I would be surprised if that hasn’t grown when the company reports earnings on February 13.  So, backing this out of the share price, the business only trades at around 30 times forward earnings, a little more palatable than 38. 

As a rule, I look for stocks to trade at a P/E multiple that is twice their growth rate (i.e., a company growing at 7% annually should trade at 14 times earnings).  Using this as a guide, Whole Foods comes in well under this when taking cash on hand out of the equation.

For comparison’s sake, I’d like to take a quick look at two of Whole Foods’ competitors, Kroger (NYSE: KR) and Harris Teeter (NYSE: HTSI).

I chose Kroger for comparison, because it is one of the largest supermarket chains and is one of the companies that Whole Foods attempts to take away nutritious-conscious customers from.  Kroger currently trades at 20.5 times earnings and is forecast to grow its earnings at a more modest 9.2% annual average.  In addition, Kroger has almost $7 billion in debt, and only $188 million in cash.  To put the potential of Whole Foods’ growth in perspective, Kroger has over 2,400 supermarkets, and only operates in 31 states.

Harris Teeter is a company that is similar in size to Whole Foods with 208 stores; however, does not have nearly the growth ambitions.  Currently trading at 20.2 times earnings, the company is projected to grow earnings at a rate just above Kroger’s, at 9.5%.  Harris Teeter also has a good balance sheet, with just a bit more cash than debt ($212 million vs. $208 million).

I believe Kroger trades at a premium because it is seen as one of the most stable companies in its sector.  Harris Teeter has a similar valuation, but its balance sheet makes it a little more attractive in my opinion.

However, if you prefer a rapidly growing company, it’s hard to beat Whole Foods.  Their balance sheet is the best I’ve seen in the grocery business, and they have an incredible about of room to expand.  Add in the fair valuation and high earnings growth expectations, and Whole Foods might be worth taking a chance on.


KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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