Why Whole Foods Will Destroy All Rivals

It's a dominant brand with extraordinary pricing power and high barriers to entry

   

Whole Foods Markets (NYSE:WFM) is what mutual fund manager Ron Baron might call a company that epitomizes a “sunrise industry” — a rapidly growing business that is closer to the beginning of its life cycle than its end. The organics movement caught hold decades ago in America and has exploded in recent years. Whole Foods is the megatron of that movement, and it will obliterate everything in its path that it hasn’t already.

The dirty little secret of the organic movement is that it plays upon people’s fears. When you strip away all the other things about it — some true and some not — the bottom line is that people choose organic over sprayed because it’s “healthier.” This is code for “less likely to cause cancer.” The power of the “C word” holds sway over American psychology because we all know someone who has suffered from the disease. In addition, the organics industry has the most brilliant marketers I’ve ever seen. This satirical link is funny because it’s true. It explains all the reasons why the organic industry is successful, and Whole Foods is the epitome of that success.

For me, the clincher came on a visit to a local Whole Foods megastore that opened in Los Angeles a few months ago. This was my first visit, and it was like entering food paradise: produce; fresh fish, poultry, meats, made-to-order burgers, chicken, sandwiches, pizza, coffee, smoothies, multiple varieties of cheeses, wines, high-end chocolates — I could go on and on. I purchased a lot of stuff and, as always, it was of the highest quality. The quality of the produce blows away every other provider’s selection in my area. Since I’m a foodie, this was an amazing experience — even Mr. Never Buys on Impulse bought a lot of stuff on impulse. Strike up another nod to Whole Foods’ success.

Oh — and it cost me a small fortune. That’s yet another reason why Whole Foods will destroy all that try to block its path: It pickpockets you…and you enjoy it.

Whether organic food is better for one’s health or not is irrelevant to me. What does matter is that I do taste the difference. I’ve even done my own blind taste tests (because I have no life). Flavor is often reason enough to spend more.

The investing lesson here should be clear by now: a dominant brand in a sunrise industry with extraordinary pricing power and high barriers to entry. Grocers are going the way of the Dodo.

Whole Foods’ net margins are almost triple those of regular grocers. And grocers are not growing, while Whole Foods is growing at a 17% annually. Grocers are loaded with debt, while Whole Foods has just $17 million, with $750 million in cash ($5 per share) and is constantly increasing free cash flow ($600 million in the trailing 12 months).

There’s only one downside with Whole Foods stock: It is as overpriced as the products the chain sells. I’m willing to pay a premium for the brand, but on 2012 earnings of $2.27, the stock has a P-E of 34. That prices the stock for fair value in 2017. So the stock is definitely a buy, but I’m putting it on my “stock market crash” list — meaning wait for the inevitable time when the stock market craters (as it did last August), and jump in then.

Lawrence Meyers does not own shares of any company mentioned.


Article printed from InvestorPlace Media, http://investorplace.com/2012/02/why-whole-foods-will-destroy-all-rivals/.

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