Whole_Food_Inc_Financial_Analysis

| Robert Pirock | | Financial Analysis BUS 410 / C / S1 2012Alvernia UniversityMartin Korlecky | whole foods market inc. | | Abstract The following undergraduate paper is an evaluation of the public company Whole Foods Market Inc. from a financial perspective for the purpose of determining whether or not this company is a sound investment. In making this determination, several factors are considered. First, a company overview, including its history and brief biography of its Co-CEOs, is provided to gain insight and an understanding of where the company came from, where it stands currently, and the direction it is going. Second, a comparison of key financial ratios between Whole Foods and their three primary competitors- Safeway, Costco and The Kroger Co. is made to determine the fiscal health and stability of the company from an industry average standpoint. In conducting this analysis, six basic financial analysis metrics are used to determine the performance of the company: P/E Ratio, Free Cash Flow Ratio and Profit Margin, as well as Inventory Turnover, Sales per Square Foot and Current Ratio, which are especially important ratios when looking at the service sector, specifically retail (The Retail Owners Institute). Finally, subsequent to this analysis, a risk analysis is conducted, including an evaluation of the company’s beta coefficient in comparison to those of its competitors to determine if there is an acceptable level of risk associated with this investment. Company History Whole Foods Market Inc. was founded in Austin, Texas by John Mackey, Rene Hardy, Craig Weller and Mark Skiles in 1980. Mackey and Hardy had started a grocery business named SaferWay in 1978 with a $45,000 loan from friends and family. In just two years, they turned it into one of the most successful grocery stores in Austin, generating over $1 million in annual revenue out of a humble space of just 1,100 square feet. In 1980, they partnered with Craig Weller and Mark Skiles, owners of Clarksville Natural Grocery, another Austin-based grocery store specializing in natural foods. The two companies joined forces and merged to form Whole Foods Market Inc. and opened their first store in September of 1980. The company enjoyed almost instant success as this market was virtually untapped with less than half a dozen natural food grocery stores in the country (Whole Foods Market). In 1984, the company began to expand; opening stores in Dallas, Houston and New Orleans and then went to the West Coast, opening a store in Palo Alto, California in 1989. During the 1990’s, Whole Foods continued to open stores from the ground up, but also made several key acquisitions of competitors and went public (NASDAQ: WFM) with an IPO of $2.13 in January of 1992. The new millennium saw Whole Foods go global, expanding to Canada in 2002 and then into Europe, when they opened seven stores in the United Kingdom in 2004. Then in 2007, Whole Foods acquired one of their biggest competitors, Wild Oats Markets with locations across the United States, Canada and the United Kingdom, making Whole Foods Markets Inc., a full-fledged multinational company. Company Overview Whole Foods Inc., over the last several years has become a household name, synonymous with the organic and “going green” trends. Its 2011 Annual Report, entitled America’s Healthiest Grocery Store, depicts this image and speaks of new initiatives to further their perception as a healthy, natural, and environmentally friendly option for consumers. Their 5-Step Animal Welfare Rating standards recognizes producers for their efforts in improving the welfare of animals and offer customers transparency and their Eco-Scale Rating System allows customers to easily identify a household cleaning product’s environmental impact and safety based on a color scale. Finally, they launched a new charity called Whole Kids Foundation, whose mission is aimed at fighting childhood obesity and supporting schools to improve children’s nutrition and wellness. The report goes on to recognize that, as demand for this type of service increases, new competitors continue to emerge, making it essential for Whole Foods to continue to differentiate themselves. In an effort to do this, they opened in-store Wellness Clubs in Chicago, Oakland, New York City, Dedham, Massachusetts and Princeton, New Jersey in January. They have also expanded their line of exclusive brands by adding approximately 400 new SKUs, reinventing some categories such as household products, and renewed their efforts around packaging. As a result, Whole Foods boasts impressive year-over-year growth, despite negative market trends with sales increasing 12% to exceed $10 billion and an operating margin improving to 5.4% (Whole Foods Market Inc.). A staggering Sales per Square Foot of $874 was recorded, compared to the industry average of $500 (Food Marketing Institute). Over the past three years, the company’s balance sheet has undergone a significant transformation from over $1 billion in debt to completely debt-free with over $800 in cash and investments. In the Letter to Stakeholders section of this report, Whole Foods states: “Our performance substantially exceeded our own expectations, as well as Wall Street’s, driving a 38% boost in our stock price during the calendar year versus the S&P 500 Index, which was flat year over year” (Whole Foods Market Inc.). Whole Foods 2011 Annual Report shows promising signs of continued expansion and success as they continue to open new stores. 32 new leases have been signed over the last 12 months, including two in Canada and three in the U.K. According to the report, they intend to open between 24 and 27 new stores in fiscal 2012 and 28 to 32 new stores in fiscal 2013. Also included in the report is the long term goal of 1,000 stores (just shy of 300 to date) in the U.S. as people continue seeking to “improve the quality of their lives and minimize their healthcare costs” (Whole Foods Market Inc.). Whole Foods seems uniquely positioned to benefit from this major demographic evolution and, according to their market research, saturation has yet to occur and their flexibility when it comes to new store size creates additional opportunities in in major metropolitan markets they have yet to enter. Beyond the U.S., there are seven stores in operation and three in development in Canada where they project sales surpassing $1 billion over the next decade. They have also opened their first store in Scotland and have five stores in development averaging 21,000 square feet in size scheduled to open in the U.K. over the next two years. The report points to the performance of these new stores serving as benchmarks and providing valuable insight into the long-term potential of the U.K. market as well as potential expansion opportunities in other international markets. CEO and Management Team Co-Founder John Mackey is Co-CEO along with Walter Robb who shares some commonalities with Mackey. Robb also opened his own grocery business in 1976 with a $2,000 loan from his father upon graduating Stanford University (Powell). He ran it for ten years, sold it, and then began running a three-store chain called Whole Living Foods in San Francisco for three years. Robb then started up another store that he sold to Whole Foods before it opened, which became store No. 11 for the company. Following this, he joined Whole Foods. In a 2006 interview with blogger Bonnie Azab Powell, Robb discusses how he and Mackey are also kindred spirits when it comes to corporate responsibility and “walking the walk” when it comes to the Core Values of the company. They are both paid equally and will not allow themselves to be paid more than 14% of the company’s average and. In 2006, they each made $608,000 which, compared to most CEO salaries among Fortune 500 companies, is refreshingly humble (Powell). He goes on to describe Mackey as a “visionary” and “conscious capitalist” and talks about their adamancy in donating 5% of their after-tax profits, involving themselves in the community and participating in micro-lending projects in 45 countries. Under their direction and unique philosophy, Whole Foods has been ranked in the Fortune 500 and the Fortune 500 “100 Best Companies to Work For” list each of the last 15 years, with 2011 rankings of 273 and 24 respectively (Whole Foods Market Inc.). Financial Analysis Ratios and Competitor Comparison To begin this analysis, we will take a look at three key metrics of the service sector: Inventory Turnover, Sales per Square Foot and Current Ratio, as they are of fundamental importance, especially in the retail subset of this sector. It should be noted that Whole Foods dominates the niche market of organic and natural foods and has a slightly different demographic and target market than the companies it is being compared to. However, for our purposes here, this analysis provides a reasonable comparison of where Whole Foods Market Inc. stands among large-chain grocery stores. Following the above three metrics are three more basic financial analysis ratios, Price-to-Earnings Ratio (P/E), Free Cash Flow and Profit Margin. These metrics will aid in further measuring Whole Foods Market Inc.’s performance both in their industry as well as for their shareholders, giving us further insight into whether this company is a solid investment choice. The spreadsheet on the following page details these metrics for Whole Foods and the three main large chains, Safeway, Costco and The Kroger Co. over the past two fiscal years for each company and includes industry averages. An explanation and analysis of each of these metrics follows this table. As the data indicate, Whole Foods Market leads their competitors in just about every metric, some by a quite substantial margin. We shall discuss the first three metrics which are especially important in the grocery business, beginning with Inventory Turnover Ratio. This is a ratio that reflects a company’s ability to sell their inventory and is calculated by dividing their total sales by total inventories to obtain the number of times inventories are sold and restocked throughout a given time period (in our case, one year). This number is then usually compared to an industry benchmark and the higher the number, the more efficient a company is at turning this asset into profits, whereas if the number is low, a company is sitting on their inventory for a longer period of time and thus is not as efficient at turning it into profits (Brigham & Houston 89). Whole Foods is most recent Inventory Turnover Ratio is 19 times per year, about 65% higher the industry average. This indicates that they are very effectively moving product in and out of their stores, optimizing their revenue generating potential, whereas all of their competitors are below the industry average over the last two years. Sales per Square Foot is the next metric we analyzed and is one of the most common ratios used in retail, especially the grocery business. This is a simple but telling calculation of a stores ability to maximize their selling space obtained by dividing the aggregate sales of all their locations by the total square footage of all their stores (Retail Owners Institute). Once again, Whole Foods is well ahead of both the industry average and their competitors with an astonishing $874 million per square foot, almost 75% above the industry average of approximately $500 million. All of their competitors we analyzed exceed this average as well; however none come close to Whole Foods. Next, we looked at the Current Ratio, a liquidity ratio calculated by dividing a company’s total current assets by their total current liabilities. This ratio gives an investor insight into whether or not a company is able to meet its short-term debt obligations and be able to remain a viable organization (Brigham & Houston 87). Again Whole Foods with a Current Ratio of 1.9 times assets to debt exceeds the industry average of 1.4 and is ahead of each of the competitors we looked at as well. This tells a prospective investor that the financial health of Whole Foods is quite well and they have very little risk of defaulting on any short-term obligations. The next metrics we analyzed are basic financial analysis ratios which demonstrate how the company’s financial performance fares against their competition. The three we chose, Price-to-Earnings Ratio, Free Cash Flow and Profit Margin are especially beneficial for investors to understand as they provide valuable insight into a company’s operational efficiency, its ability to generate revenue, and, of particular importance to investors, the growth prospects of the company. The Price-to-Earnings Ratio, or P/E, is perhaps the most often looked at ratio for prospective investors and measures how much per dollar of reported profits investors are willing to pay. It is calculated by dividing the Price per Share of common stock by the Earnings per Share and is used to indicate the anticipated growth and relative risk of investing in a company (Brigham & Houston 98). Whole Foods has an excellent P/E Ratio of 40.19 as of 3/30/12, already 20% ahead of the close of 2011’s impressive 33.61. The industry average is 26.07, so once again Whole Foods is well out in front of its competition. Next, we turn our attention to Free Cash Flow which is “the amount of cash that can be withdrawn without harming a firm’s ability to operate and produce future cash flows” and is typically used to indicate to investors how much of a company’s cash can be distributed to its shareholders (Brigham & Houston 67). It is calculated by adding back depreciation into a firm’s EBIT and then subtracting out its capital expenditures (change in current assets) and increase in net working capital (change in payables and accruals). Here, Whole Foods is slightly below the industry average and the competitors we analyzed. This is perhaps due to the fact that, over the last three years, whole foods has gone from over $1 billion in debt to completely debt-free, which of course, will affect its free cash flow, since there is no long-term debt financing any of its operating costs or capital expenditures. Finally, we analyze Whole Foods Profit Margin, or “the bottom line.” It is calculated by dividing a firm’s Net Income by its sales and is used to determine how much revenue a company generates per dollar of sales, thus giving an investor insight into the company’s operating efficiency. Whole Food’s Profit Margin of 3.49% in 2011 is more than double than industry average of 1.5%, which is about where each of the competitors we analyzed are at as well, suggesting that Whole Foods is extremely efficient from an operation standpoint. This is no surprise as the firm is debt-free, and therefore has virtually zero interest expense, which increases its Net Income. All six of the financial ratios we analyzed indicate that Whole Foods Market Inc. is performing well ahead of its competition and industry averages, indicating that the company is a great investment. To gain more even more insight, we know will take a look at Whole Foods from a historic perspective to measure its growth and risk. The chart on the following page, generated from Yahoo! Finance, graphs the Price per Share of Whole Foods stock over the last two years, as well as that of its competitors included in this analysis, followed by a brief explanation and analysis of the chart. Historical Data and Risk Analysis Is the data on the preceding chart indicate, Whole Foods’ stock has steadily increased well ahead of its competition, but at a marginally volatile pace, suggesting that the risk of investing in this company is slightly above average. Instead of analyzing the standard deviation of the stock price, we have chosen to look at the beta coefficient instead. Below is a table measuring the current betas of Whole Foods and its competitors giving us a simple but effective indication of Whole Food’s relative risk among its competitors. Company March 30, 2012 Beta Coefficient (MSN Money) WFM 1.10 SWY .76 COST .66 KR .40 As indicated by the above data, Whole Foods’ stock prices are more volatile than those for its competition. A beta coefficient of 1.0 would indicate that a stock’s price changes at the same pace as the market overall, making the risk of investing in that particular stock average. The higher above 1.0, the riskier the stock and a beta coefficient of less than 1.0 is considered to of less risky than average (Brigham & Houston 245-248). Although Whole Foods’ beta is only slighter greater than the 1.0 average, it is 25% - 175% riskier than its competitors. However, its returns, as indicated by the Yahoo! Finance graph, are substantially higher. The particular investor’s goals and risk aversion would therefore need to be taken into consideration on an individual basis when deciding whether or not to invest in Whole Foods Market Inc. Finally, we evaluate the historical distribution of dividends, another feature of particular importance to investors. The chart below, obtained from Forbes.com, outlines the distribution of dividends for Whole Foods since January 2004. With exception to the January 2006 distribution of $2.15 per share, Whole Foods dividend yield for investors have been conservative, but consistent, staying around $.15 per share. This shows that the company is relatively stable and, again, the particular investor’s individual goals from a dividend payment standpoint would have to be considered in deciding whether or not he or she would want to invest in Whole Foods. 01/11/12 0.140 09/15/11 0.100 06/22/11 0.100 04/08/11 0.100 01/06/11 0.100 07/09/08 0.200 04/09/08 0.200 01/09/08 0.200 10/10/07 0.180 04/11/07 0.180 01/10/07 0.180 10/11/06 0.150 07/12/06 0.150 04/11/06 0.150 01/11/06 2.150 10/12/05 0.250 07/13/05 0.250 04/13/05 0.250 01/05/05 0.190 10/06/04 0.150 07/07/04 0.150 04/06/04 0.150 01/02/04 0.15 Conclusion To re-cap the analysis, we provided a brief company history to paint a picture of how the company came to be, where it is presently and where it is going in the future. We also took a look at its management team, specifically the Co-CEOs, conducted a ratio analysis with six primary financial analysis metrics, followed by a risk assessment of the company based upon its beta coefficient and historical dividend distributions. According to this research, it can safely be said that Whole Foods Market Inc. is a relatively safe and smart investment. MSN Money gives it a 6 out of 10 rating and states: “Whole Foods Market Inc., a large-cap growth company in the consumer services sector, is expected to match the market over the next six months with less than average risk” (MSN Money). The data we obtained and analyzed, shows that Whole foods surpasses the industry average in most of the categories we looked at and has a growing a demographic as the culture continues to shift toward a more environmentally friendly and health conscious consumer, which is Whole Foods’ target market. Finally, as indicated by its 2011 FY report, the company has a clearly defined vision and strategy for expansion, showing promise for future growth. For an investor who is looking for a long-term investment with average to slightly above average risk and historically above average returns, Whole Foods Market Inc. would be a solid additional to his or her portfolio. References Annual Reports.com (2012) Retrieved from http://www.annualreports.com. Bloomberg BusinessWeek. (2012). Retrieved from http://investing.businessweek.com/research /stocks/financials/ratios.asp'ticker=. Brigham, E. F. & Houston, J. F. (2009). Fundamentals of Financial Management 12th Edition. Mason, OH: South-Western Cengage Learning. 67, 87, 89, 98, 245-248. Food Marketers International. Supermarket Facts. Retrieved from http://www.fmi.org/factsfigs /'fuseaction=superfact. Forbes.com. (2012). Retrieved from http://www.forbes.com/sites/dividendchannel/2012/03/30/ wfm-ex-dividend-reminder-4312/. Powell, Bonnie Azab. (2006). Corporate Board Member Magazine. Retrieved from http:// www. bonnie powell.com/wholefoods.html. The Retail Owners Institute.com Retrieved from http://retailowner.com/StoreBenchmarks/ FoodandBeverageStoresSupermarketsGroceryStores/tabid/231/Default.aspx. Whole Foods Market. (2012). Whole Foods Market Annual Review: America’s Healthiest Market. Retrieved from http://www.wholefoodsmarket.com/company/pdfs/ar11.pdf Whole Foods Market. (2012). Company History: Pieces of the Whole. Retrieved from http://www.wholefoodsmarket.com/company/history.php. Yahoo! Finance. (2012). Retrieved from http://finance.yahoo.com. YCharts.com. (2012). Retrieved from http://ycharts.com/companies/WFM/free_cash_flow#.