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Whole Foods
WILTAMUTH: I don't think investors have any patience for acquisitions in the grocery space. If you look back to the 1990s, it's just littered with value-destroying deals, accretion that was promised but never delivered, and big acquisition premiums paid.
WOLF: You are probably right because the industry is not well-regarded, but I think Kroger could pull it off.
GIBLEN: You could justify a year of dilution, and maybe more, if you said a particular acquisition would change the course of U.S. food retailing history and be transformative for Safeway, Kroger or whoever the acquirer is.
SN: Can Whole Foods maintain its forward momentum?
WOLF: Whole Foods doesn't have a national competitor. It acquired all its competition — Bread & Circus, Fresh Fields, Mrs. Gooch's, Wild Oats. It was brilliant, and Whole Foods learned from each one.
There are some potential competitors in the Pacific Northwest and other Western regions, but there is nobody nationally to threaten Whole Foods right now. Two years ago you could have said perhaps Trader Joe's was enough of a threat in dry grocery. But Whole Foods has chosen to selectively match Trader Joe's on price in categories where Trader Joe's has maybe two items and Whole Foods has 10. It will match them on the two that Trader Joe's carries but be at a higher market price on the other eight that Trader Joe's doesn't stock, thereby taking away some of Trader Joe's value advantage through category management.
Whole Foods has been an acquisition story more than a new-store growth story. Over the last five years it's grown the store base by an average of 25 units a year, but it bought Wild Oats in the middle so it has actually averaged out to 13 stores a year through acquisition and 12 net new stores. Its peak years were last year and five years ago, when it opened approximately 16 net stores. But I think the next phase will all be new-store growth.
WILTAMUTH: I think the key for Whole Foods is that it learns from its mistakes. During the downturns, it backed off its indulgent capital spending; the box size has come down; it's gotten out of some of its more aggressive larger leases; and it's really started to focus on cost control. This is a company that for years thought that if you focused on cost control you'd kill the golden goose. Now it seems to be willing to work on margins and sales. It is not just a sales story any more — that's the beauty of it. There is nothing to complain about on its fundamentals. Whole Foods is back, and it is riding the upper-income consumer recovery. It's fixed its price image.
ADLER: Whole Foods talks all the time about how its own initiatives have helped it recover. Perhaps it's simply that the high-end consumer has recovered. So how much of it do you think is really due to steps the company has taken?
WOLF: I think Whole Foods is a very successful, aggressive company that is really doing much better. Just compare it with Wild Oats. Wild Oats couldn't comp, whereas Whole Foods has doubled the sales per square foot Wild Oats was doing. And that should tell you enough. Just think about those two companies — one was crummy and one is excellent. I think Whole Foods is one of the best companies in America. One thing about [co-CEO] John Mackey — he can be a little erratic and people always focus on the negatives, but this guy is about as competitively tough as they come, and the company is therefore very adaptive.
CERANKOSKY: I believe Whole Foods can sustain its momentum because it had a very differentiated store base going into the downturn. It's made a few mistakes, and it's learned from them — for example, in the area of capital allocation. Now it's getting a higher return on investment, being more cost-conscious and opening somewhat smaller boxes that are highly differentiated, so it still has a lot of sales momentum ahead of it, and I think it can keep it going. It doesn't look like anybody is as differentiated. You hear about Safeway's lifestyle stores being differentiated, but no one is as differentiated as Whole Foods.
ADLER: I do think Whole Foods stuck with premium for too long without having a mid-level price point.
WOLF: John Mackey recently suggested the chain could go too far with cost containment. For example, the chain's approach to perishables shrink — it realized it should be using more refrigeration for items like grapes. That's brilliant — keep it fresh. But for other types of perishables, do you keep something overnight that you might have thrown out before? Maybe the grocery store down the street keeps it two nights. That's where it gets tricky. So there is a limit to how much margin you are going to get out of more efficient operations in areas like shrink control.
But what do you think of its growth plans? Is it going to be able to double the number of stores it opens? Execute it and really be a growth story?
GIBLEN: The exciting thing is, it is embracing a smaller store concept.
WOLF: … because right now it is a 5% square-footage-growth company.
HEINBOCKEL: I don't think it is going to be a 15% or 20% store-growth company. I don't know about reaching 1,000 stores either, which is what it's talking about. Our saturation analysis, which focuses on households with annual incomes of $75,000 and above, would suggest only 700 to 750 stores. To get to 1,000 would mean Whole Foods would have to appeal to a broader customer base, which is possible, given its smaller boxes and lower prices, but it's certainly not a slam dunk.
WOLF: How many do you think it can do a year?
HEINBOCKEL: It can do as many as it wants to do because there are few real bottlenecks. There's probably no bottleneck in capital because it is building smaller stores, nor is the bottleneck in real estate. The bottleneck will be people and building stores the right way. At the end of the day, it will be opening no more than 30 or 35 stores a year three or four years down the road, and if it is smart, it will limit it to that and still grow at 8% or 9%, and that is fine. That is not super-charged growth, but it's good enough to grow the top line at 12% to 14%.
MUSHKIN: We're dealing with a very bifurcated economy where the upper 25% doesn't want to shop at the same places as the bottom 75%. The top 25% seems to want to completely segregate itself from the rest of America. That goes for food-away-from-home and food-at-home. That's the Whole Foods customer.
If you look at all the companies — Fresh Direct, Fresh Market, Earth Fare in the Southeast, Sprouts on the West Coast — this upper-end income area is a huge growth opportunity because if you look at how much money these people are spending on food-at-home, they have a fairly sizable runway to spend more for food if they choose to allocate their discretionary dollars in that direction instead of for Gucci bags. They have discretionary dollars. So the growth opportunity is there for Whole Foods in spades. There is no one else doing it like Whole Foods does because it's not just about high-end. It's also a lifestyle choice. People we call “YEMmies” — young, educated mothers — want to shop Whole Foods because the company stands for what they want to stand for — things like humane treatment of animals, local sourcing. It is really a belief system. So we feel the growth opportunities are there.
Will Whole Foods be able to execute? Having Walter Robb as co-CEO is clearly improving execution. One thing about John Mackey, though, is that he learns his lessons really well. He doesn't like to admit a mistake, but once he's admitted it, he becomes almost like an evangelist. Given that, it's hard to imagine the company will repeat the mistakes it made with new-store development in 2007 and 2008.
ADLER: Based on what Mackey said, I don't think Whole Foods is going to grow at a rate of 10% or higher, though to get to 1,000 stores, you do have to believe it can find a way to appeal to more people in places like Omaha. Whole Foods has already put one store there, but it said it put it in the wrong location. But can it find a way to add another two or three stores in second-tier markets like Omaha? Maybe it will have to go to third-tier markets.
WILTAMUTH: Let's not forget it has one toe in London.
WOLF: Many years ago I was able to see a schedule of Whole Foods' sales per week by store, so I did some demographic studies to figure out how sales varied by customers' income and education levels, and it turns out there was no correlation — perhaps because people drive long distances to shop its stores. That sits very well for its saturation because stores in a lot of different places still attracted plenty of business. What's going to be interesting is when it starts putting second stores in Omaha or Richmond or wherever.
