The Low-Down: Whole Paycheck? High Prices and the Need to Cut Them Leads to Wilting Stock Price for Whole Foods

It's like one of those menu items described as 'two ways:' Whole Foods, the health-wise upscale food emporium whose prices are so stratospheric it's known as Whole Paycheck, is getting double-teamed.

It's pricing strategy has invited competitors' market penetration at lower costs, cutting share, and at the same time, investors' perception that the company is vulnerable both because it is under attack and because it may have to lower prices to respond has caused its stock price to wilt to the tune of several billion dollars.

The basic problem is that WF has tapped out the obvious gentrified urban wealth centers, forcing it to go mano a mano with the massive national chains who find that the price umbrella creates lots of opportunities for them to offer similar fare at lower price points. This puts them in classic Clayton Christensen 'Innovator's Dilemma' territory. The implication is that there are limits, especially in this bifurcated economy and excess isnt forever. JL

Annie Gasparo reports in the Wall Street Journal:

To fend off new competition and attract customers in new markets it has had to lower the high prices—and profit margins—that earned it the moniker "whole paycheck."

Investors are realizing that Whole Foods Market Inc. is a victim of its own success.

Shares in the natural and organic grocery pioneer plunged nearly 19% on Wednesday, vaporizing more than $3 billion of the company's market value, after it reduced its sales and earnings outlook for the third time in six months.

Whole Foods also reported flat earnings for the latest quarter and revealed that a key measure of sales growth hit its weakest pace since early in the U.S. economic recovery more than four years ago.

Whole Foods' years of rapid growth demonstrated consumer demand for natural and organic foods that were once niche products. The Austin, Texas company, founded in 1980, now has about 380 stores, and revenue last year of $12.9 billion.

Nationwide, sales of natural and organic foods now amount to roughly $50 billion a year. Investors had adored Whole Foods, giving it a market value at times exceeding that of Kroger Co. , the nation's largest mainstream grocery chain, which has seven times as many grocery stores.

But its accomplishment drew broad new competition, from mainstream retailers like Kroger and Safeway Inc. and Fresh Market Inc. Wal-Mart Stores Inc. last month said it struck a deal with Wild Oats to launch 100 mostly organic products that will be priced 25% cheaper than national brands.

Phoenix-based Sprouts, which has about 170 stores, on Wednesday said earnings rose 86% for the latest quarter and raised its forecast for the year, pushing its shares up 6% in after-hours trading. The shares had dropped 12% as of 4 p.m.

Its shares had fallen 45% from their peak in October through Wednesday's market close amid concerns about over expansion and competition among specialty grocers.Sprouts Chief Executive Doug Sanders credited Sprouts' focus on affordable prices, which attracted customers who wouldn't otherwise be able to buy natural and organic foods.
Whole Foods has largely tapped out its core demographic in upscale urban neighborhoods. The company's solution has been to expand beyond its comfort zone in new areas such as poorer neighborhoods, smaller cities and suburbs. It has recently opened stores in Detroit and West Des Moines, Iowa, and plans to open one in Chicago's South side next year. To fend off new competition and attract customers in those new markets it has had to lower the high prices—and profit margins—that earned it the moniker "whole paycheck."
"There's certainly a very rich competitive system out there right now. We recognize that. No one's going to give us any business," Co-Chief Executive Walter Robb said on a conference call with analysts late Tuesday. The company declined to comment on Wednesday on the decline in its share price.

Tuesday's forecast underscored the new reality. The company projected sales at stores open at least a year will grow in 5% to 5.5% in the current fiscal year ending in September, compared with an average of 8% annually for the past 15 years.

The company says it is also reducing store expenses to help insulate its profit margins, and is investing in things like grocery delivery, exclusive products, and enticing extras, such as the greenhouse on the roof of its new Brooklyn, N.Y., store.

Some analysts say the grocer isn't doing enough to compete in this new environment. They want it to cut prices even more quickly and conspicuously.

"I'm not really hearing anything that's suggesting management is taking this situation as seriously as some investors want you to," Ken Goldman, a J.P. Morgan Chase & Co. analyst, said to Whole Foods executives on a conference call.

Charles Grom, a Sterne Agee & Leach Inc. analyst, said Whole Foods needs to better promote its lower prices and special deals. "You're just going to lower the prices and hope that the customers start to recognize it over time?" he questioned.

Co-founder and co-CEO John Mackey acknowledged that "We haven't been investing in price as aggressively as we probably needed to." And Whole Foods said it is "experimenting" with some marketing strategies now.

But Mr. Robb also said "we're never going to be in a race to the bottom; chase [customers] only on value, only on price. That's not who we are."

Whole Foods' share-price drop on Wednesday, down $9.02 to $38.93, cost Mr. Mackey more than $8 million based on his latest disclosed ownership stake.

Many investors remain bullish about Whole Foods' business-even if its valuation had gone too high. Whole Foods' stock has typically traded in recent years around 35 times its latest annual earnings, compared with about 15 times for Kroger. After Wednesday, Whole Foods trades around 26 times earnings.

"The stock got a little pricey. When you have consistent linear returns, the stock market will put a premium on it," said Russ Piazza, chairman of Front Street Capital Management Inc., a Missoula, Mont.-based money manager that owns Whole Foods shares.

Mr. Piazza said Front Street bought more shares on Wednesday's decline. He likened Whole Foods' situation to that of Starbucks Corp , which created a market for high-end coffee shops that drew competition, and then over expanded before regrouping a few years ago. "No one is challenging the potential for the Starbucks brand now," he said. "Wall Street has a short-term view."