A happy customer is a repeat customer, willing to pay a higher price for a superior experience. This is how Whole Foods Market, Inc. (NASDAQ:WFM) operates its business. Grocery shopping at supermarkets long ago became an unpleasant chore, full of apathetic teenage workers making minimum wage and, depending on the supermarket, sometimes unclean conditions. In exchange for this misery prices are low, attracting the most dollar-conscious shoppers. Of course, some supermarkets are better than others, but there’s very little customer loyalty. Often people simply go where the prices are the lowest, thus driving margins lower and lower.
Whole Foods is different. The company pays its employees well, an average of $15 an hour, with many receiving benefits. This makes for happy, attentive employees which make the shopping experience far more pleasant compared to traditional supermarkets. Even with these higher labor costs Whole Foods enjoys the highest margins in the industry. Compared to competitors SUPERVALU INC. (NYSE:SVU), The Kroger Co. (NYSE:KR), and Safeway Inc. (NYSE:SWY), Whole Foods’ gross margin looks enviable.
What’s more, while competitors have seen their gross margins decline over the past decade Whole Foods has kept it essentially flat. This would suggest that the company is carving out a moat in the supermarket industry. Operating margin tells a similar story.
Whole Foods has managed to recover from the financial crisis and push operating margins above pre-crisis levels, while competitors’ operating margins continue to decline. Whole Foods’ operating margin is almost three times that of Safeway and four times that of Kroger.
Earning below expectations
Earlier this month Whole Foods reported its quarterly earnings, with EPS and revenue in line with analyst estimates. However, same store sales came in at 7.2%, below the consensus estimate of 7.7%. This sent the shares tumbling, falling from around $96 to around $85.
Analysts are wrong more often than they’re right, so the fact that the market responds so violently to a miss like this is beyond me. But this drop in price may open an opportunity to buy Whole Foods at a discount. A growth stock like this is more difficult to value than a slow-growing company, so estimates will be inherently rough. I’ll start with the balance sheet.
The balance sheet
At the end of the most recent quarter Whole Foods has $1.13 billion in cash and investments and no debt. With a diluted share count of 188 million the company has just over $6 in net cash per share. This net cash position gives Whole Foods the ability to expand the store count rapidly without taking on debt. With a share price around $86 the market is valuing all of Whole Foods’ future profits at $80 per share.