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Whole Foods Market: All Growth Drivers Intact

 November 12, 2012 01:31 AM


(By Mani) Whole Foods Market, Inc. (NASDAQ: WFM) continues to ramp up its new store pipeline, reaching 79 stores in the fourth quarter. However, Whole Foods still has much more work to do to reach its previous peak. The growing pipeline is needed if it wants to reach its 1,000 store target in the US within the next 10-15 years.

Austin, Texas-based Whole Foods is a food retailer focused on natural and organic foods. At the end of 2011, Whole Foods operated 317 stores in North America and the UK.

The company, which is currently 1 percent of the total US food retail market, is one of the top 10 food and drug retailers in the US in terms of sales. Its average store size is approximately 40,000 square feet. In 2011, it generated annual revenue per square foot of $877.

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Whole Foods is generating stronger sales growth by opening stores with higher new store productivity. The smaller store sizes generate high revenue/sqft in its first year but still grow comparable sales strongly. WFM has generated strong new store productivity since 2009.

"We expect square footage growth to accelerate in the next 5 years. WFM has guided to 8% sqft growth in 2013FY and 8%-9% sqft growth in 14FY. We expect sqft growth to average 9.5% over the next 5 years, putting WFM at 500 stores in 2017FY," UBS analyst Jason DeRise wrote in a note to clients.

Since 2010, the company has generated fairly consistent comparable store sales above 8 percent a year. The majority of this growth has been driven by traffic growth. In the fourth quarter, traffic grew 7 percent.

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Even the oldest stores are growing comparable sales at a fast rate, at 6.4 percent in the fourth quarter. Importantly, the newest stores, which are smaller, but opening with high revenue/sqft are seeing strong double digit comparable sales growth.

"We believe WFM is able to generate high comparable sales growth despite other premium retailers seeing a significant slow down due to its price investments. These investments have been funded by improved efficiency, which have also allowed WFM to see its gross margin expand in 2012FY," DeRise said.

In addition, Whole Foods is getting more efficient as the driver of its gross margin expansion is its inventory efficiency. Its days of inventory are now below 20 on a first-in-first-out (FIFO) basis, which is the lowest it has ever been. This has been attributed to better inventory management as well as the effect of smaller stores generating high traffic. There is a strong, positive cycle at work.

Whole Foods sales are 2/3 perishable and prepared foods. More traffic per store drives more purchases mean less spoilage of perishable items, which means more efficient inventories, which means better prices for consumers, which means more traffic to the store.

"We believe this supports our view that WFM's valuation multiples do not need to contract in the next 5 years as the high growth story will likely continue at a fast rate in years 5-10 as well (with WFM only half way to its 1,000 store target in 17FY)," the analyst said.

The combination of smaller stores, high, new store productivity, better inventory management, and strong comparable sales growth led to a recovery in Whole Foods return on invested capital.

For the fourth quarter, Whole Foods' profit rose to $112.73 million, or 60 cents per share, from $75.48 million, or 42 cents per share, last year. Excluding the impact of an extra week, adjusted earnings for the quarter were 56 cents per share, which missed consensus view of 60 cents per share.

Quarterly sales grew 24 percent to $2.91 billion. Excluding the extra one-week, sales were $2.69 billion. Street analysts, on average, had estimated revenues of $2.91 billion for the quarter.

Comparable store sales for the quarter increased 8.5 percent. Gross margins for the three-month period advanced 76 basis points to 35.3 percent, driven by improvements in both cost of goods sold and occupancy costs as a percent of sales.

For the full year 2013, the company continues to expect earnings of $2.83 to $2.87 per share while analysts currently expect earnings of $2.90 per share for fiscal year 2013. The company sees full year 2013 sales growth of 12 to 14 percent on a comparable store sales growth of 6.5 to 8.5 percent.

"Over the next 5 years, we model 17% sales CAGR, with 16% gross profit CAGR (effect of price investments). However, operating leverage allows for 17% EBITDAR CAGR. 18% EBITDA CAGR and 19% EBIT CAGR. We estimate 20% EPS CAGR," DeRise added.

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