Consumers' interest in the natural and organic food industry continues to grow in the U.S. while the overall industry food sales have been almost flat as consumers believe that organic food satisfies their concerns over the effects of pesticides, hormones, antibiotics and high processing and do not contain artificial ingredients. The organic food sales in the U.S. comprise nearly half of global organic food sales and most of the country's consumers buy organic food at mainstream grocery stores.
The trend has really helped Whole Foods Market (WFM), the largest chain of natural and organic products in the U.S., to pick up growth. The company's revenues in the last five fiscal years have grown at a CAGR of approximately 61% which is a truly remarkable rate. Moreover, its management has efficiently converted the revenues into net profits as the profits in the last five years have grown at a CAGR of 363% which is even more remarkable!
On account of this impressive growth in both the top and bottom lines, Deutsche Bank has given the company's stock a buy rating, with a price target of $70 while the stock currently trades at $55.9. So analysts assume that the stock has an upside potential of 25%.
Revenue Drivers
Whole Foods' top line growth depends on its ability to increase sales in its identical stores and open new stores. In FY13 the company opened 32 new stores and acquired 6 stores which created an even stronger foothold in the industry. The company also acquired smaller stores to seek additional opportunities and those stores reported better than expected results.
In FY13, the company's sales totaled around $12.9 billion reflecting an increase of 10.4% over the previous year. Besides the newly opened and acquired stores, the drivers for this revenue growth were an increase in comparable and identical store sales. Comparable store sales increased 6.9% while identical store sales increased 6.6%. However, this increase in comparable store sales was the lowest of the last three years because in the fourth quarter of FY13 the company bore the effects of macroeconomic conditions in the country. In the last quarter its comparable store sales rose by only 5.9%.
Due to this decline, the company cut its FY14 earnings forecast. Now it expects the comparable store sales growth to be in the range 5.5% to 7% and identical store sales growth to be in the range of 5% to 6.5%. The total sales in FY14 are projected to grow by 11% to 13% YoY from $14.3 billion to $14.6 billion compared to $12.9 billion in 2013.
As the conditions in the US improve and the consumer confidence index rises due to higher employment opportunities I expect that the company will easily achieve or even surpass this revenue target. Moreover, consumers are more and more inclined towards natural and organic foods due to the recommendations of health associates, especially the younger and high income population, so this will give the company additional opportunities to achieve or beat its target.
Apart from opening and acquiring stores, Whole Foods Market is also expanding its customer base through portfolio expansion. During October 2013, it introduced Whole Paws, an exclusive line of premium value pet food, featuring 24 products for dogs and cats. The pet food industry and particularly the premium pet food is one of the fastest growing industries in the US as the pet ownership in the country is continuously increasing and in the next five years the pet industry is projected to maintain strong margins. This launch will expand the company's revenues as well as its margins leaving it with good profits.
Net Earnings Drivers
The positive revenue growth is not the only reason behind the company's huge earnings growth. The company's cost cutting policies have also contributed a lot towards revenue growth. In FY13, the company's gross profit increased by 31 basis points driven primarily by an improvement in occupancy costs and cost of goods sold.
Both the direct store expenses and the general and administrative expenses as a percentage of sales decreased 10 basis points in 2013 reflecting leverage in wages. The pre-opening expenses, as a percentage of sales, remained the same even though the company opened seven more stores this year compared to 2012.The operating income as a percentage of sales increased 40 basis points.
For FY14, management expects the general and administrative expenses to remain the same or decline by 10 basis points and operating income to rise by 10 to 20 basis points.
Looking at the company's historic cost-reducing measures, I expect that it would easily be able to achieve these targets by improving the net earnings in 2014.
Balance Sheet
The company has a very strong liquidity position as both its current and quick ratios are greater than 1. This gives a fair idea that the company can easily meet its short term financial obligations and can overcome any unexpected operational disruption. The quick ratio shows that even if the inventory, a major part of its current assets and quite illiquid than other current assets, becomes obsolete or loses its value, the company would still be able to meet its obligations by converting its other current assets.
Source: Company's 10K
Now let us analyze the company's debt profile. Whole Foods Market has a very negligible amount of debt on its balance sheet compared to its earnings and cash flows. At the end of FY13the company had a total debt of only $27 million while its net earnings and cash flows at this time period were $551 million and $1,009 million respectively. So, the debt can easily be paid through its cash flows.
Source: Company's 10K
The debt-to-equity ratio significantly declined from 2010 as the company paid a $490 million debt in 2011 related to the acquisition it made in 2007.
Returns
Whole Foods Market's efficiency in using its assets and equity is increasing over the years. Its improved margins have enabled it to generate higher revenues by using its assets and equity. Sometimes the return on equity can be manipulated by high financial leverage but as Whole Foods has a very small amount of debt its ROE cannot be manipulated.
Source: Company's 10K
Final Thoughts
This is the first time that I have seen a company with all of its operations and strategies going in the right direction. Income statement, balance sheet and cash flow statement, all of these financial statements are as fresh and healthy as Whole Foods' products. The company's future also looks bright after seeing its industry outlook, its historic performance and management's estimates. I would say that Whole Foods Market has a great potential to pay a handsome amount of profits to investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.
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