Can you guess which retailing stock has nearly matched J.C. Penney’s (JCP) 11.6% decline during February? If your mind immediately darted to Target (TGT), Wal-Mart Stores (WMT), Best Buy (BBY) or any of J.C. Penney’s rivals in catering to the bargain-conscious community of shoppers still reeling under the twin blow of higher gasoline prices and higher payroll taxes, you couldn’t be more wrong. The company in question caters to quite a different demographic: those more able, willing and likely to pay higher prices for higher quality without feeling much pain, as seen in a stock chart.
Whole Foods Market (WFM) may have established a reputation as a premium retailer, providing organic and natural foods to affluent consumers, but its stock price has taken a blow in the wake of the company’s decision to offer shoppers more discounts and comments from executives that the company’s profit margins are likely to suffer as a result over the next three quarters or so. The move is part of the company’s expansion plan: after establishing numerous stores in affluent city hubs, it now is opening more in smaller communities, where potential customers are willing to pay for value, but not necessarily to pay the premium that Whole Foods traditionally has been able to charge. Or at least, that is the view of founder and co-CEO John Mackey, whose mission is broader than simply trying to make a profit selling food. Rather, he wants to woo shoppers who aren’t eating as healthily as they could be in the doors of Whole Foods, and he believes the best way to do so is by emphasizing value.
Whole Foods has done a great job of boosting margins, one reason why even after the selloff in the stock, the company’s shares still trade at 32 times trailing earnings and nearly 30 times its prospective earnings, slightly more than double the ratio for the S&P 500. But the company’s growth rates, in terms of both revenue and profit, are several times the rates seen for the S&P 500, explaining the premium valuation.
The question now is whether investors – those who have so far hung on to the stock during the selloff and anyone attracted to it because of the selling pressure – will have the patience to wait for the company to prove that it’s capable of delivering more blockbuster results down the road. Whole Foods is a bet on demographic trends, not the retailing sector, and CEO Mackey clearly is convinced that he can sacrifice something on profit margins today in exchange for a larger number of stores, of happy customers and resilient rates of growth in revenues and earnings down the road.
In contrast to J.C. Penney’s own flawed turnaround strategy, the new approach by Whole Foods has a solid chance of succeeding. Partly that’s because it isn’t been conducted out of desperation, or the need for a turnaround, but as part of a bid to extend the company’s growth, whereas in Penney’s case, the new management schemes appear increasingly like a frantic effort to stave off inevitable collapse. Whole Foods isn’t waiting for its traditional business model to be challenged, as fewer new customers in its core demographic remain to be won over, but instead trying to tweak its model in its own time and on its own terms.
Odds are that today’s wobbly retail market environment will change, but to the extent that Whole Foods succeeds in winning new customers, they’ll stick around – and perhaps even end up paying higher prices. The stock may not look like a deep value investment even at its recent lows, but to the extent that the market reacts poorly to future news of margin compression, it may become still more attractive to investors in search of long-term growth.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at firstname.lastname@example.org.
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