Investors are paying for management’s talent at optimization
Over time, Whole Foods has become increasingly efficient at optimizing its operations. One of the long-term trends I am following with interest is the company’s average store size. From the chart below you can see that up until a few years ago, Whole Foods sought to continually expand the footprint of individual stores:
Source: Whole Foods Company Earnings Release, Feb. 13, 2013.
The expansion peaked in 2007, when the average size of new stores opened was 56,500 square feet. More recently, new store size on average is on the decline, which has helped the company maintain an average aggregate size of 38,000 square feet for the last three years. According to the Food Marketing Institute, the median U.S. grocery retail store size is 46,000 feet. The last time the national average saw 38,000 feet was 1996. Why is Whole Foods so bent on controlling store size? Essentially, the company has recognized that it can obtain better results by optimizing sales per square foot, rather than just expanding average store size to sell more. The results of the last three years are worth noting:
Store size is constant, while weekly sales are rising at an appreciable rate. Earnings have also become more efficient when measured on a square foot basis:
In addition to these trends, Whole Foods has also lowered the cost of new store pre-opening expenses, from an average of $2.6 million per store in 2010 to $1.7 million per store in 2012. So on many fronts, Whole Foods’ capital is being deployed with greater impact as management perfects its game. The company’s return on invested capital is 13.1% as of its most recent fiscal quarter. This level of operational competence should lessen investors’ worry over periodic variations in Whole Foods’ robust gross margins.
The slow food movement
Whereas the typical Fortune 500 company maintains multiple business divisions, Whole Foods Market, Inc. (NASDAQ:WFM) states: “We have one operating segment, natural and organic foods supermarkets.” By keeping its focus narrow, and continually optimizing its stores, the company has the potential to return significant earnings per share to investors in the coming years. While superior margins comprise part of the company’s premium valuation, the methodical, optimized growth of the company is the better reason for an investor to accept a relatively higher stock price.
The article Whole Foods Market: Justifying the Premium originally appeared on Fool.com and is written by Asit Sharma.
Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market.
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