Grocery stores have had a rough go of it since the recession, but one grocery store stands out from the pack and represents a great buy.
There are basically two ways to earn a profit in the grocery industry: earn a high margin or make a high number of sales per dollar of assets (asset turnover).
The most commonly-used model is based on asset turnover. Low prices and loss leaders are employed by the users of this model in an attempt to attract a loyal base of customers. These stores make up for low unit profitability by selling more units.
Organic grocers like Whole Foods Market, Inc. (NASDAQ:WFM) have had success charging high mark-ups on their products. While stores that earn high margins are not able to turn over their assets as quickly as those that compete on price, they earn a higher profit on each good sold. As a result, they are able to earn a respectable profit.
Three Case Studies
Whole Foods, Safeway Inc. (NYSE:SWY), and The Kroger Co. (NYSE:KR) each have their own styles in the grocery business. Whole Foods earns high margins, Safeway is a mix of high margin and high asset turnover, and Kroger has a high asset turnover.
Each strategy has different benefits and drawbacks, but only one of these companies is worth buying.
Whole Foods Market, Inc. (NASDAQ:WFM) is rare in that it still has substantial growth ahead of it in the United States. In addition, it will earn even higher profit margins as it expands its private-label offering.
Since 2002, Whole Foods has grown sales at an annualized rate of 15.7%. More impressively, it has grown pre-tax earnings at 17.8% per year over the same period. Its high growth rate is part of the reason why the company trades at a whopping 15x EV/EBITDA and 35x earnings.