3 Grocery Stores - 1 Clear Winner

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

Depending on who you ask, the average American spends as little as $200 a month up to $700 or more on groceries.  For many people, groceries are a large percentage of their overall monthly spending outside of their rent or mortgage.  If you multiply these values by how many people use food to live – everyone alive – you would think that there is a ton of money to be made at all grocery store chains.  However, unlike other sectors like technology where net profit margins of 20% or higher are common, anything over 3-4% for a grocery store chain is nearly non-existent.  The fact is that major publicly traded grocery stores are lucky to break the 2% barrier of net profit margin, and the latest average for all chains is between 1.6-1.7%.

Whole Foods Market

“If you can’t beat them, join them.”  That is a classic saying that Whole Foods (NASDAQ: WFM) refused to follow when the company was founded in 1980.  Instead of joining the thousands of grocery store chains around the country that all compete with each other on razor-thin margins while selling pretty much the same exact products, Whole Foods decided from the beginning to not join, but exceed all with their natural and organic products.

Year-to-date, Whole Foods has seen its share price rise nearly 39% and in the last 5 years it has gone up over 104%.  What is even more amazing is that compared to last year, their net profit margins have increased from 3.39% to 4.28%.  What once appeared to be a fad is becoming the standard, as other traditional grocery store chains have tried to include aisles or sections in their own stores with natural or organic products.  The numbers don’t lie when it comes to the strength of organic and natural food fans.  In the past 3 years, Whole Foods has seen their net income to common shares almost triple from $118.75 million (2009) to $342.61 million (2011).

In my opinion the future for Whole Foods is very bright. According to their most recent earnings report, sales increased 13.6%, EPS increased 26.9%, and ROI increased 192 basis points – all year-over-year.  This is in addition to their continual rise in profit margins the last 5 years, from under 2% to approaching the 5% level.  I believe they can do this because they are now the Apple of grocery stores, as customers currently perceive their products as the highest quality available and are therefore willing to pay a higher price.  

Whole Foods currently has around 330 store locations, but they believe long-term they can handle 1000 store locations in the United States alone.  Furthermore, they plan to expand to Canada and the United Kingdom, and the company hasn't even touched some of the larger economies in Asia and Europe.  With Dr. Oz providing what seems like an hour-long organic and natural foods commercial on his daily television talk show, Whole Foods doesn’t even need to advertise. 

The company's next earnings announcement is set for Nov. 7.

<img src="http://media.ycharts.com/charts/bf8dd9d8142381761071df3f52a421d0.png" />

WFM Profit Margin Quarterly data by YCharts


Safeway (NYSE: SWY) is closer to the epitome of the typical grocery store chain when it comes to net profit margins.  The past 5 years, Safeway has had an average profit margin of 0.87%.  Compared to last year, their net profit margins have actually declined from 1.19% (2011) to 1.07% (as of 2012 Q3).  If you take a quick look at Safeway’s chart since going public in 1990, you can see that they enjoyed much of their success as a stock in the late 1990s when competition was less, customers weren't doing research on WebMD on every single thing they consumed, and the whole organic and natural food phase was niche.  To get a better perspective of how powerful a few percentage points is when it comes to net profit margins, take a look at the table below.

<table> <tbody> <tr> <td> <p><strong>Most Recent Quarter of 2012</strong></p> </td> <td> <p><strong>Total Revenue</strong></p> </td> <td> <p><strong>Net Income To Common Shares</strong></p> </td> </tr> <tr> <td> <p><strong>Whole Foods Market (WFM)</strong></p> </td> <td> <p>$2,727,279,000</p> </td> <td> <p>$116,849,000</p> </td> </tr> <tr> <td> <p><strong>Safeway (SWY)</strong></p> </td> <td> <p>$10,049,100,000</p> </td> <td> <p>$159,900,000</p> </td> </tr> </tbody> </table>

Whole Foods's total revenue was only 27% of Safeway's.  However, their net income was 73% of Safeway's.  It goes to show that every percent profit margin counts in a big way. 

Safeway’s future is somewhat secure, although increased competition and severely narrow margins have led to their share price declining over 50% the past 5 years (dividends not included), despite having a respectable 4% annual dividend yield.  Their latest earnings report shows that their income is declining year-over-year due to higher interest expenses, additional marketing expenses, and higher corporate pension expenses.  Another thing to note is that Safeway has an extraordinary high debt to cash ratio, with over $6 billion in debt versus only around $260 million in cash on the balance sheets.  In comparison, Whole Foods has $1.07 billion in cash versus just $19.12 million in debt. 

Safeway’s P/E ratio is only 7.76, which might make it a decent buy to complement their solid dividend yield (which doesn’t look endangered with a dividend payout ratio of only 31%).  In fact, their payouts have increased every year since they started giving dividends in 2005.  Safeway hasn’t seen their share price return to pre-recession levels of $30+/share, so the potential is definitely there for the stock to rise in the coming years if you believe the recovery will benefit grocery store chains.

<img src="http://media.ycharts.com/charts/a8ae3e2b963d513b4f53208b26ca2bd9.png" />

SWY Total Return Price data by YCharts


If Whole Foods is best of the best, then SuperValu (NYSE: SVU) is the worst of the worst.  In the past 5 years, SuperValu’s share price has declined over 94%, with over 73% in declines this year alone.  Speaking of razor-thin margins, SuperValu has none.  Their net profit margin has been -2.65% on average the past 5 years (20 quarters).  The January 2006 “Albertsons Deal” looks to be one of the larger catalysts that has since led to the destruction of the stock.  Prior to the deal, SVU saw its stock soar for decades.

Perhaps SuperValuU is another example of the classic phrase, “more is not always better”.  After their many acquisitions, SuperValu operates its 2500+ stores under multiple retail brands or chains that include Acme Markets, Albertsons, Cub Foods, Farm Fresh & Pharmacy, Hornbacher’s, Jewel-Osco, Lucky Stores, Osco Pharmacy, Save-A-Lot, Shaw’s and Star Market, Shop ‘n Save, Shoppers Food, and SuperValu Pharmacies.  How does a CEO run a company with so many different brands underneath it?  Well the former SuperValue CEO no longer does, after hewas terminated July 30 of this year.

The future of SuperValu is questionable, to say the least.  One could say they are too big to fail.  With so many of their stores providing a clear necessity (food) for so many millions of people around the country, how does one deal with the tragedy that is SuperValu?  Supervalu is rumored to be looking for a buyer, and with a market cap of just $467 million and change, it doesn’t seem so difficult at first glance.  However, if you take into account that the buyer is going to be taking on over $6 billion in debt and over 2500 stores that are more or less unprofitable, then finding a buyer is much harder.  If SuperValu does find a buyer, there is a strong possibility that investors get in today could see some relatively quick returns percentage-wise if the buyer offers a premium for outstanding shares.

<img src="http://media.ycharts.com/charts/b19d87d0bfda0d503a18c27cc0118ea8.png" />

SVU Profit Margin Quarterly data by YCharts

Interested in Additional Analysis?

It's hard to believe that a grocery store could book investors more than 30-times their initial investment, but that's just what Whole Foods has done for those who saw the organic trend coming some 20 years ago. However, it may not be too late to participate in the long-term growth of this organic foods powerhouse. In this brand new premium report on the company, The Motley Fool walks through the key must-know items for every Whole Foods investor, including the key opportunities and threats facing the company. We're also providing a full year of regular analyst updates to go with it, so make sure to claim your copy today by clicking here.

mikecart1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Supervalu and Whole Foods Market. Motley Fool newsletter services recommend Supervalu, Supervalu, Supervalu, and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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