But while Whole Foods’ business will continue to expand and improve over the next decade, the rich valuation will not reward investors. It’s best to stay away from Whole Foods for now.
While Whole Foods Market, Inc. (NASDAQ:WFM) earns high margins and a low asset turnover, Safeway sells only some of its products at a high margin and competes more on asset turnover. But the strategy has not been too successful.
Safeway began a re-branding effort in 2005 called ‘Lifestyle.’ Essentially, the company sells higher-margin products under its Lifestyle brand. However, margins have only decreased since the re-branding effort began.
On the plus side, the recent completion of Safeway’s re-branding efforts means that the company should earn more free cash flow in the future. Unfortunately, Safeway’s stores have not been able to recover customer traffic since the recession.
Safeway is in an awkward position between being a premium grocer that earns higher-than-discount margins and being a grocer that compete on price. The company will continue to decline until it picks a clear strategy.
However, Safeway is really cheap based on historical performance; it trades at just 4x EV/EBITDA and 10x earnings. It also trades at just 10x free cash flow even though free cash flow is expected to increase in the years ahead. But its recent performance makes the stock a pass.
Finally, The Kroger Co. (NYSE:KR) is a ‘premium’ store that has low prices where it counts and has a high asset turnover. The company has used its gas stations as a loss leader to drive customer traffic to its stores. This has allowed the company to gain market share while the rest of the industry backpedals from the recession. In addition, Kroger has a long runway for growth in the United States.
At just 4.3x EV/EBITDA and 15x normalized free cash flow, Kroger is not only a great company — it’s also inexpensive.
Best Bet in the Grocery Business
Whole Foods Market, Inc. (NASDAQ:WFM) is in the best position to take advantage of the long-term trend toward organic food, but its valuation is not attractive at all. Safeway is really cheap, but its future is uncertain and it will likely continue its decline for many years.
The Kroger Co. (NYSE:KR), on the other hand, has a solid base from which to expand and is currently being offered at a reasonable multiple of normalized free cash flow. A good business at a good price makes Kroger the best bet in the grocery business.
The article This Grocery Store Is the Best Bet originally appeared on Fool.com and is written by Ted Cooper.
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