Growing More than Organic Food

By Matthew McMichen - June 19, 2012 | Tickers: SWY, KR, WFM | 0 Comments

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I love nothing more than finding a company that actually cares more about the products it's selling than the wealth those products are generating.  More than that, though, I love it when the market rewards those companies for producing quality products.  

Don't get me wrong here -- there are many companies whose primary motivation is profit, and the market definitely rewards those companies when they achieve that goal (we'll save the moral and socioeconomic implications of such a motive for another post).  But the companies that excite me the most (and the ones that I'm more likely to invest in for the long-term) are those companies whose motivation as a company is quality output that's beneficial in some way to both the consumers and the investors.

A Natural Company with Natural Motives

In my humble opinion, Whole Foods Market (NASDAQ: WFM) is one of those companies.  And no, I'm not just saying that because I currently reside in Austin, Texas, and find any excuse I can to shop there.  Although, that's at least a good indicator to me that Whole Foods is doing something right, because I actually enjoy visiting the store and spending money on their products.  There aren't too many companies that I actually enjoy spending money on.

What do I mean though, when I say a company cares more about selling quality products than making a quick buck?  If you happen to be the nerdy type, such as myself, and enjoy reading through a company's annual reports, you should thumb through the Whole Foods FY'11 Annual Report.  More specifically, take a peak at the "Our Core Values" section, and make note of the "highest quality," "satisfying customers," "supporting team happiness," "caring about our communities," and "promoting the health of our stakeholders" language used.  Only once -- and it's the fourth one on the list -- does a mention of wealth and profit occur.  And if you've ever stepped foot in a Whole Foods, you'll see right away that this isn't just talk.  Their core values are evident throughout the entire store.

Doesn't every company care about its products, though?  Sure, I think that can be said to some degree, but I also believe it's evident in this day and age that companies exist more for the purpose of generating profits.  Or at least that's their primary motive, whereas quality output is secondary (granted, you may be hard-pressed to get any executive to admit it).  If you ask me, the reverse should be true.  Corporations should exist for the primary purpose of serving and benefiting the community and world at large.  The beauty in this though, is that profitability typically follows.  If you fill a need within the community and do so in a quality, consumer-oriented way, then the market will reward you.  

Quality Comes at a Price

This is exactly why I'm so excited to see Whole Foods priced with the seemingly high P/E ratio you see it at today.  Sure, a trailing 43.2 P/E seems incredibly high and may be hard to stomach, especially when its main competitors, Kroger (NYSE: KR) and Safeway (NYSE: SWY), are currently trading at trailing P/E ratios of 21.8 and 10.1, respectively. But, there's a reason the market has priced Whole Foods at a premium.  As I said, companies are typically rewarded for producing/selling quality products that truly benefit the community.  That being said, should you invest your money in Whole Foods today at nearly $95/share?  I mean, it would've been great to get in on this one around 3 years ago when the opening price was a mere $19.06/share.  But has the market’s rewarding of this stock reached its ceiling?

Growing More than Organic Food

Let’s take a look at the numbers.  In the past 5 years, Whole Foods has managed to increase its sales by roughly 80% from $5.6B to $10.1B, with a corresponding increase in net income of approximately 68%.  With the boost in income, Whole Foods was able to increase its EPS from $1.46 to $1.96 (or roughly 34%).  More importantly, in the past 5 years Whole Foods has increased its free cash flow by approximately 247%.

Taking a look back at what Whole Foods has done historically is good and all, but what about the future?  You’d be a fool (and not the good kind) to assume that a company will perform well just because it has done so historically.  However, that’s just not the mechanics of stock valuations.  Stock prices, while finding their base in historical performance, typically represent analyst and investor estimates of future cash flow.  So the real question is this: Can Whole Foods replicate its past performance going forward and continue to grow its free cash flow?

Based on the company’s 2011 Annual Report, the grocery industry had sales of nearly $563 billion in 2010.  Within this category, the natural food product industry had approximately $65 billion in sales.  Of that $65 billion, Whole Foods had only $9 billion in 2010 sales.  If you ask me, Whole Foods has a lot of room to grow in the natural food industry.  Not only that, but considering the heightened public awareness of health benefits associated with natural/organic food, Whole Foods stands to gain additional market share within the $563 billion grocery industry.

The Foolish Bottom Line

So, can Whole Foods replicate its past performance and take advantage of growth opportunities in its industry?  The answer is yes, it absolutely can.  The better question, is will it?  Based on the company’s commitment to high quality, consumer-oriented products, I believe the answer to that question is yes as well.  As I said earlier, the market rewards this type of behavior, and I don’t see Whole Foods backing down from its core values anytime soon.

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