Five Things I Learned Reading Whole Food's Annual Report

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

Digging into a company's annual report, or 10-K, is a great way to spot hidden trends that get in the headlines. 

Last week, Fool columnist Morgan Housel illustrated this point clearly in his article 5 Things I Learned From Reading Altria's Annual Report (and his follow-up on Visa).

So to keep the theme going, here're five interesting nuggets I learned from Whole Food's Market (NASDAQ: WFM) annual report.

Whole Foods is a incredibly efficient marketer

I knew Whole Foods wasn't big on glitzy marketing, but I didn't know just how little the company spent on traditional advertising.

"We spend much less on advertising and marketing than other supermarkets - approximately 0.4% of our total sales in fiscal year 2012. Instead, we rely heavily on word-of-mouth advocacy by our shoppers, which we believe is more valuable than traditional advertising" Whole Food's 10-K

Last year, Whole Food's spent only $47 million on marketing. Rather than purchase traditional advertisements, the company prefers to partner with local non-profits establishing the company within the communities in which it operates.

How does that compare to traditional rivals?

Let's consider Safeway (NYSE: SWY). In 2012, the company spent $497 million in advertising and grossed $44 billion in sales. Safeway spent 10 times more in advertising to earn just less than four times more in revenue. 

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The problem with spending this much money on marketing is that in a tight margin business like groceries, small savings translate into big gains on the bottom line. Perhaps Safeway should steal some ideas from the Whole Food's playbook. 

Hidden company to play the organic boom

Buried in Whole Food's risk section was a amazing stock pick.

"Disruption of significant supplier relationships could negatively affect our business. United Natural Foods, Inc. (NASDAQ: UNFI) is our single largest third-party supplier, accounting for approximately 31% of our total purchases in fiscal years 2012 and 2011. During fiscal year 2010, we extended our long-term relationship with UNFI as our primary supplier of dry grocery and frozen food products through 2020 and added two of our regions to our distribution arrangement beginning in fiscal year 2011." Whole Food's 10-K

United Natural Foods is a hidden play on the booming organic grocery business and Whole Food's expansion. Given the ten-year distribution deal, United Natural now has an incredibly visible source of earnings growth.

But in addition to Whole Food's, United Natural has several other growth opportunities.

The company is finding new customers such as institutional food service provides and small grocers. United Natural is also poised to benefit as traditional supermarkets like Safeway and Kroger expand their organic and natural food offerings. 

The company is also ramping up its international expansion. In 2010, SunOpta sold its Canadian food distribution business to United Natural. United is now focused on expanding its Canada operations with a sales target of $500 million or 10% of its total sales.

For stingy investors, United Natural may also present a cheaper alternative. Whole Food's and United Natural are priced at 35 and 25 times trailing earnings respectively.

 Private label is here to stay

During the recession, Whole Food's expanded its selection of cheaper, private label brands as consumers traded down. Today, store brands account for a large 11% of sales. 

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What's noticeable is how little this has changed since the recession. In spite of an improving economy, customers are sticking to cheaper private labels. 

I noticed the same trend when skimming through Kroger's and Safeway's annual reports. 

This means two things for investors:

First - higher margins for retailers now that they're cutting out the middlemen.

Second - brands don't matter anymore (or at least less). This spells big trouble for some companies like Kellogg, Proctor and Gamble, and General Mills

New customers driving growth

In 2012, Whole Food's same store sales increased 8.8%. But it was interesting to see the breakdown. 

"...we saw our identical store sales breakout move toward approximately 80% transaction count and 20% basket size...Basket size is partially impacted by our growth in new customers, who tend to have a smaller average basket size." Whole Food's 10-K

While existing customers are increasing their basket size, most of the growth is coming from new customers who are just trying organic foods for the first time.

That represents a huge opportunity to get these customers to buy more and higher priced products. This also indicates that Whole Foods still has a long growth runway in exiting markets. 

Stores are getting smaller

Whole Food's has cut the size of its new stores down significantly.

In 2008, the company's average store was a 49,000 square feet behemoth. Today, new stores are 25% smaller and cost 35% less to open.

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Why might Whole Food's be doing this. Again several reasons:

First - smaller stores are better suited for secondary markets where the company sees most of its expansion opportunity.

Second - smaller stores are cheaper to operate with fewer employees and services.

Third - limited shelf space means only the best selling products will be stocked increasing profitability. 

Foolish bottom line

While I have previously been bullish on the company, subtle details in the company's 10-K  continue to backup the bull thesis.

Whole Foods is refining it's growth strategy, increasing the likelihood that it will be able to hit its 1,000 store target. The fact that sales are still being driven by new customers means the company should be able to sustain a high rate of same store sales growth for longer than expected.

Whole Food's potential may be much larger than investors anticipate. 

Robert Baillieul 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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