Whole Foods Market: The Deutsche Bank Report
UV7269
Rev. Sept. 28, 2017
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Whole Foods Market: The Deutsche Bank Report
The latest numbers coming out of Whole Foods Market, Inc. (Whole Foods) in May 2014 took Deutsche
Bank research analyst Karen Short and her team by surprise. On May 6, Whole Foods reported just $0.38 per
share in its quarterly earnings report, missing Wall Street’s consensus of $0.41 and cutting earnings guidance
for the remainder of the year. The company’s share price fell 19% to $38.93 the next day as Whole Foods’
management acknowledged that it faced an increasingly competitive environment that could compress margins
and slow expansion. The only upbeat news was the 20% increase in the company’s quarterly dividend, up from
$0.10 to $0.12 per share. Short and her team knew this was not the first time the market believed Whole Foods
had gone stale. In 2006, Whole Foods’ stock had also declined 20% over fears of slowing growth and increasing
competition, but had since bounced back and outperformed both its competition and the
oader market (see
Exhibit 1 for stock price performance). Nevertheless, it was time for Short and her team to discuss how the
news altered their outlook for the company in a revised analyst report. The main point of discussion would
certainly be whether Whole Foods still had a recipe for success.
The Grocery Industry
The U.S. grocery industry as a whole had historically been a low-growth industry, and, as a result of fierce
competition, had typically maintained low margins. In 2012, the industry recorded over $600 billion in sales, a
3% increase from the previous year.1 Real demand growth was strongly tied to population growth, and
consensus estimates for nominal long-term growth rate were between 2% and 3%.2 Key segments included
conventional grocers such as Kroger, Publix, Safeway, and Albertsons; supercenters such as Wal-Mart and
Target; natural grocers such as Whole Foods, Sprouts Farmers Market (Sprouts), and The Fresh Market (Fresh
Market); and wholesalers such as Costco and Sam’s Club. Conventional grocers remained the primary
destination for shoppers, but competition from Wal-Mart, wholesalers, and other low-price vendors had driven
down conventional grocers’ share of food dollars for over a decade; for example, Wal-Mart was the largest food
etailer in the United States in 2014, with 25% market share.3 Exhibit 2 provides market share information for
the U.S. grocery market. The na
ow margins and limited growth opportunities favored large competitors that
could leverage efficiencies in purchasing and distribution to pass savings on to the consumer. As a result, many
small competitors had been acquired or forced to close. Consumers were extremely price conscious and came
to expect promotions (which were largely funded by manufacturers), and most shoppers did not have strong
attachments to particular retail outlets.
1 Whole Foods Market annual report, 2013.
2 Hoover’s Inc., Grocery Stores & Supermarkets Industry Report, 2015.
3 Hoover’s Inc.
For the exclusive use of N. Williams, 2020.
This document is authorized for use only by Ngozi Williams in Financial Reporting and Analyses taught by ABHIJIT BARUA, Florida International University from Aug 2020 to Feb 2021.
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Given this environment, companies relentlessly searched for opportunities to achieve growth and improve
margins. Many grocers had implemented loyalty programs to reward repeat shoppers, and most were trying to
improve the in-store customer experience, for instance by using self-checkout lines and other operational
adjustments to reduce checkout times, a source of frequent complaints. Given the high percentage of perishable
goods in the industry, supply chain management was essential, and companies were using improved technology
to more efficiently plan their inventories. Grocers also began promoting prepared foods, which could command
higher margins and reach consumers who did not regularly cook their own meals. Finally, most major grocers
offered private-label products, which allowed them to offer low prices while still capturing sufficient margins.
Despite operating in a competitive and low-growth industry, natural grocers had grown rapidly over the
past two decades. Increasingly health-conscious consumers were concerned about the source and content of
their food, which fueled natural grocers’ sustained growth (over 20% per year since 1990) despite their
comparatively higher prices.4 In 2012, natural and organic products accounted for $81 billion in total sales in
the United States, a 10% increase from the previous year.5 Organic products, which were more na
owly defined
than natural products, accounted for about $28 billion of these sales and were expected to top $35 billion by
the end of XXXXXXXXXXExhibit 3 provides growth forecast and share data on the natural and organic segments. As
of 2014, 45% of Americans explicitly sought to include organic food in their meals, and more than half of the
country’s 18–29-year-old population sought it out.7 By specializing in such products, natural grocers were able
to carve out a profitable niche: the three leading natural grocers (Whole Foods, Sprouts, and Fresh Market) had
EBITDA margins of 9.5%, 7.7%, and 9.1% respectively, whereas Kroger, the leading conventional
supermarket, had an EBITDA margin of only 4.5%.8 Exhibits 4 and 5 contain operating and financial
information for selected companies in the U.S. grocery industry.
As expected, the segment’s attractiveness sparked increasing competition from both new entrants and
established players from the other competing segments. Wal-Mart, Kroger, and others launched organic
offerings targeted at health-conscious consumers, often at a much lower price point than similar products at
natural grocers. While Whole Foods, other natural grocers, independent retailers, and food cooperatives were
the primary source of organic products in the 1990s, by 2006, half of the country’s organic food was sold
through conventional supermarkets.9 By 2014, organic products were available in over 20,000 natural food
stores and nearly three out of four conventional grocers.10
Even in the face of this competition, Whole Foods maintained a position as the market leader for the
natural and organic industry. As many grocers joined the natural and organic bandwagon, Whole Foods
defended against misrepresentative claims. Whole Foods had recently introduced a system to rate fresh produce
on a number of criteria, including sustainability and other characteristics important to natural and organic
customers.11 The company’s website listed over 75 substances that were prohibited in all of its products and
published additional measures for meat, seafood, and produce selection to ensure consumers had insight into
the quality of their food. Whole Foods was the only U.S. retailer that labeled genetically modified foods, an area
of some concern to health-conscious consumers.
4 USDA, Organic Market Overview, 2014.
5 Whole Foods Market annual report, 2013.
6 USDA.
7 Rebecca Riffkin, “Forty-Five Percent of Americans Seek Out Organic Food,” Gallup, August 7, 2014.
8 Author calculations using companies’ 10-Ks.
9 Carolyn Dimitri and Lydia Oberholtzer, “Expanding Demand for Organic Foods Brings Changes in Marketing,” Amber Waves, March 1, 2010.
10 USDA.
11 Whole Foods Market annual report, 2013.
For the exclusive use of N. Williams, 2020.
This document is authorized for use only by Ngozi Williams in Financial Reporting and Analyses taught by ABHIJIT BARUA, Florida International University from Aug 2020 to Feb 2021.
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Despite its remarkable growth, the natural and organic industry was not without its critics. Several academic
and government studies had concluded that organic products were not significantly more nutritious than
nonorganic goods and claimed that the inefficiency of organic production could harm the environment.
Moreover, the continuing lack of official legal definitions of terms such as “natural” arguably made them
effectively meaningless: one botanist argued the segment was “99% marketing and public perception.”12
Whole Foods Market
Whole Foods traced its roots to 1978, when John Mackey and Renee Lawson opened a small organic grocer
called SaferWay in Austin, Texas. Two years later, it partnered with Craig Weller and Mark Skiles of Clarksville
Natural Grocery to launch the first Whole Foods Market, one of the country’s first natural and organic
supermarkets. In 1984, the company began expanding within Texas and in 1988 made its first move across state
lines by acquiring the Louisiana-based Whole Foods Company; the next year it launched its first store in
California. The company went public in 1992 and grew rapidly during the 1990s through both new store
openings and acquisitions. Whole Foods launched its first international store in Canada in 2002 and acquired a
natural supermarket chain in the United Kingdom in XXXXXXXXXXThe company had consistently maintained high
growth throughout the new century by increasing same-store sales and expanding its store count; same-store
sales grew more than 5% in every year except 2008 and 2009, when the global financial crisis
ought America
into a severe recession. By 2013, the company’s growth strategy had moved away from acquisitions, and
management saw improving same-store sales and continued new openings as its primary growth
opportunities.14 Same-store sales—the most important growth criteria Wall Street used to evaluate retailers—
had grown by at least 7% every year since 2010, far above other established