Whole Foods Market: A Risky Bet Without The Right Acquirer

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Whole Foods Market, Inc. (NASDAQ:WFM) somehow forgot to continue building its competitive advantage and have a firmer grasp of its supply chain, all the time when the organic food space was expanding to have included many traditional grocers, big and small, that have no problem to source organic foods of their own. Suppliers of organic foods have also seen seismic changes in their operations with big, publicly traded food companies buying out independent organic growers. This ultimately changes the dynamics of organic food supplies and presents a challenge to Whole Foods’ sourcing ability.

It’s a totally different business environment that Whole Foods finds itself in today, making it that much harder for the company to once again stay on top of everything. Chances are slim that Whole Foods can chart a new course in the current marketplace all by itself through internal reform. Investors have to get used to the idea that an independent Whole Foods may never get back to its heydays. But who should be the outside help? And that’s the point of contention. We believe that a private equity firm with ownerships of a range of organic growers is the right acquirer for Whole Foods.

Forget about a takeover by another food retailer such as Albertsons (NYSE:ABS) or The Kroger Co. (NYSE:KR), both of which have been mentioned in a potential Whole Foods acquisition. Whole Foods doesn’t need another supermarket chain to show it how cost-effective using centralized buying can be when sourcing organic food supplies. The reason Whole Foods has had a region-by-region sourcing system, despite its resulting higher costs, is because it serves the company’s desire to have locally produced foods with regional flavors and creativity.

It’s only a matter of company policy to change from regional sourcing to centralized buying. Whole Foods may choose to do to cut down on costs. Albertsons or Kroger or any other grocer doesn’t hold the secret about how to source cheaply from national suppliers. The upside is probably limited to economies of scale if Whole Foods is acquired by a competitor with parallel operations. It doesn’t really address Whole Foods’ weakening competitive positions, that is, having lost its exclusiveness as an organic retailer. The problem can be solved only by strengthening Whole Foods’ supply chain and building exclusive relationships with its suppliers.

Whole Foods has allowed the problem to develop for too long. Annual sales growth has been very slow since at least 2012, unusual for a market leading player like itself. This is accompanied by stagnant quarterly sales within each of the five years between 2012 and 2017. Having not found a way to regain healthy sales growth, the company is now turning to cost control to help preserve earnings.

Quarterly Sales Between 2012 and 2017 (in billions)

2012 2013 2014
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
3.4 2.7 2.7 2.9 3.9 3.0 3.1 3.0 4.2 3.3 3.4 3.3
2015 2016 2017
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
4.7 3.6 3.6 3.4 4.8 3.7 3.7 3.5 4.9

Whole Foods seems to agree that the way to control costs is to switch from regional sourcing to national buying. But this may further reduce Whole Foods’ competitiveness as it will further lose the uniqueness of the foods it can bring to the store. In the end, the company may be competing with mainstream grocers mostly on pricing, risking to become another mainstream grocer itself.

The fundamental problem underlying Whole Foods’ current state of poor performance is within its overall control of organic food supplies, or the lack of them, relative to other grocers’ growing ability to source their own organic foods. Investments in vertical integration would have played a key role in helping solidify Whole Foods’ supply operations. It would have helped not only securing an exclusiveness image, but also removing some of its operating costs into non-cash, amortized investment expenses, a boost at least to cash flows.

We tried to address the vertical integration issue back in Sept. 1, 2015, in a research titled, ‘For Whole Foods Market, Vertical Integration May Become its Whole Point of Sale.’ Unfortunately, the company hasn’t made any significant progress as to investing in and taking control of critical growers in its supply chain over the past year and 10 months since our research publication. Our argument is more urgent now than it was then when the company still had the time to entertain the idea and then implement it.

Whole Foods has actually missed the train. Today’s organic grower landscape has shifted against its favor with many independent organic growers gobbled up by large, traditional food companies. Imagine to negotiate a friendly supply contract with them on organic foods they now control. Who else has been investing in organic growers? That’s right, private equity firms.

A private equity firm with organic-food-grower ownerships is a logical fit for Whole Foods. It would be a potential image concern for any of the big food companies trying to associate itself with Whole Foods, even though they now own organic food growers. One such company is General Mills Inc. (NYSE:GIS), the owner of Nature Valley and Cascadian Farm, among many others, which supply organic cereals, granola, frozen fruits, vegetables, etc.

One private equity firm that could immediately address Whole Foods’ needs is North Castle Partners. The company has invested in at least 30 organic brands, a significant value proposition when talking about strengthening the sourcing of organic food supplies for a new Whole Foods. North Castle typically invests in small-cap consumer companies in healthy, active and sustainable living sectors.

We’re not speculating on North Castle potentially acquiring Whole Foods, which has a market cap of around $11 billion, but that’s the kind of private equity firms that can come to Whole Foods’ rescue. Absent such sensible buyout discussions, Whole Foods stock is at best a hold at this time. We don’t favor other turnaround propositions and it would be a sell for us in those situations.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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