Whole Foods Market

UVA-F-1776
Rev. Sept. 24, 2018
Whole Foods Market: The Deutsche Bank Report
The latest numbers coming out of Whole Foods Market, Inc. (Whole Foods), in May 2014 took Deutsche
Bank research analyst Karen Short and her team by surprise. On May 6, Whole Foods reported just $0.38 per
share in its quarterly earnings report, missing Wall Street s consensus of $0.41 and cutting earnings guidance
for the remainder of the ear. The compan s share price fell 19% to $38.93 the next day as Whole Foods
management acknowledged that it faced an increasingly competitive environment that could compress margins
and slow expansion. The only upbeat news was the 20% increase in the compan s quarterl dividend, up from
$0.10 to $0.12 per share. Short and her team knew this was not the first time the market believed Whole Foods
had gone stale. In 2006, Whole Foods stock had also declined 20% over fears of slowing growth and increasing
competition, but had since bounced back and outperformed both its competition and the broader market (see
Exhibit 1 for stock price performance). Nevertheless, it was time for Short and her team to discuss how the
news altered their outlook for the company in a revised analyst report. The main point of discussion would
certainly be whether Whole Foods still had a recipe for success.
The Grocery Industry
The US grocery industry as a whole had historically been a low-growth industry, and, as a result of fierce
competition, had typically maintained low margins. In 2012, the industry recorded over $600 billion in sales, a
3% increase from the previous year.1 Real demand growth was strongly tied to population growth, and
consensus estimates for nominal long-term growth rate were between 2% and 3%.2 Key segments included
conventional grocers such as Kroger, Publix, Safeway, and Albertsons; supercenters such as Wal-Mart and
Target; natural grocers such as Whole Foods, Sprouts Farmers Market (Sprouts), and The Fresh Market (Fresh
Market); and wholesalers such as Costco and Sam s Club. Conventional grocers remained the primary
destination for shoppers, but competition from Wal-Mart, wholesalers, and other low-price vendors had driven
down conventional grocers share of food dollars for over a decade; for example, Wal-Mart was the largest food
retailer in the United States in 2014, with 25% market share.3 Exhibit 2 provides market share information for
the US grocery market. The narrow margins and limited growth opportunities favored large competitors that
could leverage efficiencies in purchasing and distribution to pass savings on to the consumer. As a result, many
small competitors had been acquired or forced to close. Consumers were extremely price conscious and came
to expect promotions (which were largely funded by manufacturers), and most shoppers did not have strong
attachments to particular retail outlets.
1 Whole Foods Market annual report, 2013.

2 Hoover s Inc., Grocery Stores & Supermarkets Industry Report, 2015.
3 Hoover s Inc.
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Page 2 UVA-F-1776
Given this environment, companies relentlessly searched for opportunities to achieve growth and improve
margins. Many grocers had implemented loyalty programs to reward repeat shoppers, and most were trying to
improve the in-store customer experience, for instance by using self-checkout lines and other operational
adjustments to reduce checkout times, a source of frequent complaints. Given the high percentage of perishable
goods in the industry, supply chain management was essential, and companies were using improved technology
to plan their inventories more efficiently. Grocers also began promoting prepared foods, which could command
higher margins and reach consumers who did not regularly cook their own meals. Finally, most major grocers
offered private-label products, which allowed them to offer low prices while still capturing sufficient margins.
Despite operating in a competitive and low-growth industry, natural grocers had grown rapidly over the
past two decades. Increasingly health-conscious consumers were concerned about the source and content of
their food, which fueled natural grocers sustained growth (over 20% per year since 1990) despite their
comparatively higher prices.4 In 2012, natural and organic products accounted for $81 billion in total sales in
the United States, a 10% increase from the previous year.5 Organic products, which were more narrowly defined
than natural products, accounted for about $28 billion of these sales and were expected to top $35 billion by
the end of 2014.6 Exhibit 3 provides growth forecast and share data on the natural and organic segments. As
of 2014, 45% of Americans explicitly sought to include organic food in their meals, and more than half of the
countr s 18 29-year-old population sought it out.7 By specializing in such products, natural grocers were able
to carve out a profitable niche: the three leading natural grocers (Whole Foods, Sprouts, and Fresh Market) had
EBITDA margins of 9.5%, 7.7%, and 9.1% respectively, whereas Kroger, the leading conventional
supermarket, had an EBITDA margin of only 4.5%.8 Exhibits 4 and 5 contain operating and financial
information for selected companies in the US grocery industry.
As e pected, the segment s attractiveness sparked increasing competition from both new entrants and
established players from the other competing segments. Wal-Mart, Kroger, and others launched organic
offerings targeted at health-conscious consumers, often at a much lower price point than similar products at
natural grocers. While Whole Foods, other natural grocers, independent retailers, and food cooperatives were
the primary source of organic products in the 1990s, by 2006, half of the countr s organic food was sold
through conventional supermarkets.9 By 2014, organic products were available in over 20,000 natural food
stores and nearly three out of four conventional grocers.10
Even in the face of this competition, Whole Foods maintained a position as the market leader for the
natural and organic industry. As many grocers joined the natural and organic bandwagon, Whole Foods
defended against misrepresentative claims. Whole Foods had recently introduced a system to rate fresh produce
on a number of criteria, including sustainability and other characteristics important to natural and organic
customers.11 The compan s website listed over 75 substances that were prohibited in all of its products and
published additional measures for meat, seafood, and produce selection to ensure consumers had insight into
the quality of their food. Whole Foods was the only US retailer that labeled genetically modified foods, an area
of some concern to health-conscious consumers.
4 USDA, Organic Market Overview, 2014.

6 USDA.
7 Rebecca Riffkin, Forty-Five Percent of Americans Seek Out Organic Food, Gallup, August 7, 2014.
8 Author calculations using companies 10-Ks.
9 Carolyn Dimitri and Lydia Oberholtzer, E panding Demand for Organic Foods Brings Changes in Marketing, Amber Waves, March 1, 2010.
10 USDA.
Page 3 UVA-F-1776
Despite its remarkable growth, the natural and organic industry was not without its critics. Several academic
and government studies had concluded that organic products were not significantly more nutritious than
nonorganic goods and claimed that the inefficiency of organic production could harm the environment.
Moreover, the continuing lack of official legal definitions of terms such as natural arguably made them
effectivel meaningless: one botanist argued the segment was 99% marketing and public perception. 12
Whole Foods
Whole Foods traced its roots to 1978, when John Mackey and Renee Lawson opened a small organic grocer
called SaferWay in Austin, Texas. Two years later, it partnered with Craig Weller and Mark Skiles of Clarksville
Natural Grocer to launch the first Whole Foods Market, one of the countr s first natural and organic
supermarkets. In 1984, the company began expanding within Texas, and in 1988, made its first move across
state lines by acquiring the Louisiana-based Whole Foods Company; the next year it launched its first store in
California. The company went public in 1992 and grew rapidly during the 1990s through both new store
openings and acquisitions. Whole Foods launched its first international store in Canada in 2002 and acquired a
natural supermarket chain in the United Kingdom in 2004.13 The company had consistently maintained high
growth throughout the new century by increasing same-store sales and expanding its store count; same-store
sales grew more than 5% in every year except 2008 and 2009, when the global financial crisis brought America
into a severe recession. B 2013, the compan s growth strateg had moved awa from acquisitions, and
management saw improving same-store sales and continued new openings as its primary growth
opportunities.14 Same-store sales the most important growth criteria Wall Street used to evaluate retailers
had grown by at least 7% every year since 2010, far above other established grocers growth rates even after it
began expanding its natural and organic offerings. The company had done all of this with no debt financing.
Looking forward, Whole Foods management planned to eventually operate over 1,000 stores, up from the 362
it operated as of the end of fiscal year 2013.15 Exhibit 6 contains store count and same-store sales growth
history for Whole Foods and other industry players.
Whole Foods positioned itself as the leading retailer of natural and organic foods and defined its mission
as promoting the vitalit and well-being of all individuals by supplying the highest quality, most wholesome
foods available. 16 The compan s sole operating segment was its natural and organic markets, and nearly 97%
of its revenues came from the United States. By 2013, the average Whole Foods store carried 21,000 stock-
keeping units (SKUs), and approximately 30% of sales outside the bakery and prepared-food segments were
organic. Whole Foods reported $551 million in net income on $12.9 billion in sales in 2013, making it the clear
leader of natural and organic grocers even though its numbers were still rather small compared to Kroger s net
income of $1.5 billion on more than $98 billion in sales.17
Facing increased competition in the segment, many analysts believed that Whole Foods biggest challenge
was its reputation for high prices. For instance, Whole Foods charged $2.99 for a pound of organic apples,
compared to $1.99 at Sprouts and even less at Costco.18 Indeed, many consumers derisively described the store
as Whole Pa check, and the compan had historicall opened its stores in high-income areas. In response to
12 Victim of Success, The Economist, August 2, 2014.

13 Company website.
15 Tom Ryan, Whole Foods Market Aims for 1,000 Stores in the U.S., Forbes, July 5, 2011.
18 Victim of Success.
Page 4 UVA-F-1776
this image, the company had already begun marketing private labels (365 and 365 Everyday Value), begun
competitive price matching and promotional sales, and launched a printed value guide (The Whole Deal) that
featured coupons, low-budget recipes, and other tips for price-conscious consumers.19 Additionally, many
Whole Foods supporters often pointed out that they were willing to pay a premium price for a premium
product.
The Research Report
The recent collapse of Whole Foods stock price had caught Short and her team flatfooted. After all, heated
competition in the grocery space was nothing new, even for Whole Foods, but the company had nonetheless
maintained both its favorable margins and high growth rate for years. Short, along with many other analysts
across Wall Street, had been strongly in the bull camp prior to the recent earnings report. Short s report from
the past month recommended to investors that Whole Foods stock was a bu and worth $60 per share. This
argument was based on ongoing gains to expected revenue growth and EBITDA margins in the coming year
(the report built in expectations of revenue growth of 11% and 14%, respectively, in 2014 and 2015; and
EBITDA margins of 9.4% and 9.8%, respectively, in 2014 and 2015). The main question now facing the team
was whether to adjust its financial forecast for Whole Foods in light of recent news. Exhibit 7 contains a
version of the forecast model with the assumptions used for Short s previous report. As an additional
benchmark, Exhibit 8 reports prevailing capital market information. As Short reconsidered her position, her
team fleshed out the case for both a bearish and bullish view on Whole Foods.
From the bears perspective, the natural and organic market was becoming saturated as more companies
offered organic products at lower cost. This competition would soon compress Whole Foods margins, while
at the same time stealing market share and causing same-store sales to slow or even decline.20 Several analysts
had downgraded Whole Foods after the company issued its disappointing quarterly results.21 A report put out
the previous week b another bank noted that 85% of Whole Foods stores were within three miles of a Trader
Joe s a privately owned natural grocer up from 44% in 2005; similar overlap with Sprouts had grown from
3% to 16% and with Fresh Market from 1% to 14%. Moreover, Whole Foods was running out of dense, highly
educated, high-income neighborhoods in which to open new stores, which could either force the company to
rely more on low-price offerings or slow its rapid expansion.22 Such a shift in strategy could take the company
into uncharted territory and risk its reputation as a premium brand. Finally, the bears were concerned that the
new competitive reality would cause the market to fundamentally revalue Whole Foods. The company had long
traded at a substantial premium, at times e ceeding Kroger s market value, despite the latter compan s
substantial size advantage (compared to Whole Foods, Kroger had 7.3 times as many stores that generated
7.6 times as many sales and 3.6 times as much EBITDA). Such a premium could only be justified if Whole
Foods could continue growing, both at its existing stores and in terms of its overall footprint. The team noted
that even if it cut the price target from $60 to $40, Whole Foods would still trade at a premium to its competitors
in the conventional grocers segment.
The bulls believed the combination of Whole Foods leadership in natural and organic offerings, shifting
consumer preferences, and organic food s small but rapidl growing market provided ample runwa for

20 Karen Short and Shane Higgins, The Bear vs. Bull Thesis; We Remain in the Bull Camp, Deutsche Bank, 2014.
21 Annie Gasparro, Slow to Cut Prices, Whole Foods is Punished, Wall Street Journal, May 7, 2014.
22 Edward Kelly, Judah Frommer, and Lauren Wood, Anal sis of Emerging Headwinds Suggests Pullback May Not be a Buying Opportunity,
Credit Suisse, 2014.
Page 5 UVA-F-1776
sustained growth at high margins.23 As the clear leader in the segment, Whole Foods was well positioned to
benefit from consumers increasingl health-conscious decision-making. Moreover, Whole Foods was not just
another retailer that offered natural products; it was the standard bearer and thought leader for the industry,
making it top of mind for anyone interested in the type of healthy products Whole Foods brought into the
mainstream. Its competitors were merely imitating what Whole Foods pioneered and continued to lead, giving
the company a sustainable advantage.24 While competition could put downward pressure on some of Whole
Foods prices, the company had the stature to maintain its margin targets even with competitive price cuts by
driving sales toward higher-margin categories like prepared foods, where the grocer could more readily
differentiate its products. Moreover, the compan s high prices gave it more room to adjust prices on goods
where it directly competed with lower-cost retailers; past work by Short s team had shown that Whole Foods
could match Kroger on 10,000 SKUs equivalent to all the non-private-label nonperishable products the
company offered and still maintain nearly a 35% gross margin, which was within Whole Foods target range.25
Similar analyses against other competitors also suggested ample room to selectively compete on prices while
maintaining its overall margin targets. Additionally, Whole Foods had opportunities to reduce operating
expenses, which the bulls thought would offset decline in revenue from pricing pressure over the next few
years. While some analysts were concerned that Whole Foods expansion would take it into lower-income areas
that were distinct from the compan s historical target market, the bulls believed that Whole Foods private-
label products offered a chance to provide similar, high-quality products at a more accessible price point while
protecting margins and providing a promising new avenue for growth.26 While the bulls acknowledged that
Whole Foods traded at a premium, the thought the compan s higher growth rates, attractive margins, and
position as a market leader provided ample justification for its higher valuation.
Whole Foods CEO John Mackey was firmly in the bull camp. While he acknowledged that Whole Foods
best-in-the-industry sales per square foot and margins would attract competition, he claimed, We are and will
be able to compete successfully, and that the pricing gap between Whole Foods and the competition would
not disappear.27 More importantly, he claimed that no competitor offered the quality of products that Whole
Foods could, regardless of how these competitors chose to market their products. Alluding to the lack of a
clear legal definition for natural foods, he alleged that many competitors marketed standard commercial meat
and other perishable goods under misleading labels, and said that Whole Foods could more aggressively
advertise its superior quality to maintain its differentiation from the competition. Similarly, the company was
making investments to improve the customer experience, already seen by many as one of its stronger points,
by shortening wait times and offering higher-quality self-service food. Behind the scenes, it was reallocating
support personnel on a regional rather than store-by-store basis in an effort to cut costs. After hinting at several
projects in the pipeline that would help Whole Foods thrive in the new reality of stronger competition, he said
that Whole Foods is not sitting still. We are still ver innovative!
23 Short and Higgins.

26 Scott Davis, Whole Foods Holistic Growth Plan, Forbes, April 30, 2014.
27 Author interview with John Mackey, March 22, 2016.
Page 6 UVA-F-1776
Exhibit 1
Share Price Performance of Whole Foods Market Indexed to S&P 500 Index
(January 2005 to April 2014)
Data source: Yahoo! Finance and author analysis.
Page 7 UVA-F-1776
Exhibit 2
Select Market Share Data
Grocery Sales by Channel Forecasted

Actual 2011 2016
Traditional Supermarkets 40.1% 37.4%
Supercenters 17.2% 18.5%
Convenience Stores 15.1% 15.6%
Wholesale Clubs 8.5% 9.0%
Drug Stores 5.5% 5.9%
Mass Merchandisers 4.4% 2.8%
Limited Assortment Grocery Stores 2.7% 3.7%
Dollar Stores 2.2% 2.3%
Other 4.3% 4.9%
Top Grocery Retailers in North America

2012 Revenue
($ billions)
Wal-Mart 145.0
Kroger 96.3
Costco 87.3
Target 73.1
Safeway 44.5
Loblaw Cos. 31.8
Publix 27.5
Ahold USA Retail 27.3
7-Eleven 22.0
C&S Wholesale Grocers 21.4
Delhaize America 19.5
H-E-B Grocery Co. 19.4
Sobeys 17.7
Dollar General Corp. 16.1
Meijer, Inc. 14.6
Wakefern Food Corp. 13.6
Metro Inc. 12.0
Whole Foods Market 11.7
Source: Market Share Reporter (Farmington Hills, MI: Gale, 2014) and author analysis.
Page 8 UVA-F-1776
Exhibit 3
US Store Count Forecast Natural and Organic Share versus Total Industry
2013 2014 2015 2016 2017 2018
Conventional Supermarkets 36,092 36,092 36,092 36,092 36,092 36,092
Natural and Organic Subtotal 1,367 1,572 1,808 2,079 2,391 2,750
Assumed Growth Rate 15% 15% 15% 15% 15%
N&O Share of Industry 3.6% 4.2% 4.8% 5.4% 6.2% 7.1%
Data source: Deutsche Bank Research; Food Marketing Institute.
Page 9 UVA-F-1776
Exhibit 4
Selected Operating Data for Comparable Companies
Average Sales Growth

50%
40%
30%
20%
10%
0%
-10%
-20%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Whole Foods Market

Other natural & organic
Conventional grocer
Supercenters and wholesalers
Average
EBITDA Margins
10%
8%
6%
4%
2%
0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Whole Foods Market
Other natural & organic
Conventional grocer
Supercenters and wholesalers
Note: Other natural & organic is composed of Sprouts and Fresh Market.
Conventional grocer is composed of Kroger, Safeway, and Supervalu. Supercenters
and wholesalers is composed of Wal-Mart and Costco.
Source: Company SEC filings, 2003 2013.
Page 10 UVA-F-1776
Exhibit 5
Selected Financial Data for Comparable Companies
(in millions of US dollars, except percentages, ratios, and per share data;
financial statement data as of fiscal year 2013)
Market Bond
Cap of Total Credit
Company Sales EBITDA Equity Debt Beta Rating
Natural & Organic

Whole Foods Market 12,917 1,222 14,481 0 0.70 N.A.
Sprouts Farmers Market 2,438 187 4,102 304 0.75 BB-
The Fresh Market 1,512 138 1,554 25 0.80 N.A.
Conventional Grocers
Kroger 98,375 4,428 23,679 11,311 0.70 BBB
Safeway 36,139 1,579 7,899 4,451 0.75 BBB
Supervalu 17,155 720 1,876 2,531 1.00 B-
Supercenters and Wholesalers

Wal-Mart 476,294 35,742 251,747 55,245 0.60 AA
Target 72,596 6,452 36,806 14,089 0.75 A
Costco 105,156 3,999 49,257 4,985 0.75 A+
Data sources: Value Line, Mergent Online, YCharts, Yahoo! Finance, Standard and Poor s, company SEC filings, and
author estimates.
Page 11 UVA-F-1776
Exhibit 6
Store Growth Statistics for Whole Foods and Other Industry Comparables
2008 2009 2010 2011 2012 2013

Total Stores
Trader Joe's 400
Whole Foods Market 275 284 299 311 335 362
Sprouts 36 40 43 103 148 167
Fresh Market 86 92 100 113 129 151
Natural Grocers 72
Fairway 14
Other Natural and Organic Retailers 200
Kroger 2,481 2,469 2,460 2,435 2,424 2,640
Safeway 1,739 1,725 1,694 1,678 1,641 1,335
Supervalu 2,474 2,421 2,349 2,394 2,434 2,396
Wal-Mart (including Sam's Club, US only) 4,258 4,360 4,413 4,479 4,625 4,835
Costco (US, Canada, & Mexico) 512 527 540 592 606 634
2008 2009 2010 2011 2012 2013

Same-Store Sales Growth
Whole Foods Market 4.0% -4.0% 7.0% 8.0% 8.0% 7.0%
Sprouts 9.0% 2.6% 2.3% 5.1% 9.7% 10.7%
Fresh Market -1.5% -1.1% 5.0% 5.4% 5.7% 3.2%
Kroger (excluding fuel) 5.3% 3.1% 2.5% 4.9% 3.5% 3.6%
Safeway (excluding fuel) 1.5% -4.9% -0.5% 4.9% 1.6% 0.2%
Supervalu (including fuel) 0.5% -1.2% -5.1% -6.0% -2.8% -2.4%
Wal-Mart (US only) 3.5% -0.8% -0.6% 1.6% 2.4% -0.5%
Costco (including fuel) 8.0% -4.0% 7.0% 10.0% 7.0% 6.0%
Data source: Company SEC filings; Deutsche Bank Research; Food Marketing Institute.
Page 12 UVA-F-1776
Exhibit 7
Deutsche Bank Model (in millions of US dollars, except per share figures)
Actual Actual Actual Forecast Forecast

At Fiscal Year End 2011 2012 2013 2014 2015
Store Growth 4.0% 7.7% 8.1% 10.5% 12.6%
Sales Growth 12.2% 15.7% 10.4% 11.1% 14.0%
EBITDA Margin 8.5% 9.0% 9.5% 9.4% 9.8%
Tax Rate 38.1% 38.4% 38.8% 39.0% 39.0%
Current Asset Turnover 7.0 5.6 6.5 7.0 7.1

Current Liabilities Turnover 11.5 12.0 11.9 11.6 11.6
Net PP&E / Store 6.4 6.5 6.7 6.7 6.7
Annual Dep. & Amort. / Store 1.00 0.93 0.94 0.94 0.94
Stores 311 335 362 400 450

Sales 10,108 11,699 12,917 14,351 16,360
EBITDA 859 1,055 1,222 1,352 1,600
Dep. & Amort. 311 311 339 376 423
EBIT 548 744 883 976 1,176
Taxes 209 286 343 381 459
Net Income 339 458 540 596 717
Shares Outstanding 350 364 372 372 372
Earnings per Share 0.97 1.26 1.45 1.60 1.93
Current Assets 1,453 2,103 1,980 2,050 2,304

Current Liabilities 880 977 1,088 1,238 1,406
Net Working Capital 573 1,126 892 812 898
Net PP&E 1,997 2,193 2,428 2,680 3,018
Return on Invested Capital 13.2% 13.8% 16.3% 17.1% 18.3%

Data source: Company financial reports, Deutsche Bank research, and author estimates.
Page 13 UVA-F-1776
Exhibit 8
Demographic and Capital Markets Data
US Population Growth Rates

2014-2015 0.82%
2015-2060 (Compound Annual Growth Rate) 0.70%
Yield on US Treasuries
6 Months 0.05%
1 Year 0.10%
3 Years 0.90%
5 Years 1.65%
30 Years 3.40%
Average Yields on US Corporate Bonds

5-Year 30-Year
Maturity Maturity
AA 1.90% 4.29%
A 2.09% 4.39%
BBB 2.49% 4.80%
BB 4.00% 6.83%
B 4.90% n/a
Data sources: Bloomberg and US Census Bureau.
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UVA-F-1776

Rev. Sept. 24, 2018

Whole Foods Market: The Deutsche Bank Report

The Grocery Industry

1 Whole Foods Market annual report, 2013.

4 USDA, Organic Market Overview, 2014.

12 Victim of Success, The Economist, August 2, 2014.

The Research Report

19 Whole Foods Market annual report, 2013.

Credit Suisse, 2014.

23 Short and Higgins.

Data source: Yahoo! Finance and author analysis.

Grocery Sales by Channel Forecasted

Top Grocery Retailers in North America

2013 2014 2015 2016 2017 2018

Conventional Supermarkets 36,092 36,092 36,092 36,092 36,092 36,092

Data source: Deutsche Bank Research; Food Marketing Institute.

Average Sales Growth

Source: Company SEC filings, 2003 2013.

Natural & Organic

Supercenters and Wholesalers

2008 2009 2010 2011 2012 2013

2008 2009 2010 2011 2012 2013

Actual Actual Actual Forecast Forecast

Current Asset Turnover 7.0 5.6 6.5 7.0 7.1

Stores 311 335 362 400 450

Current Assets 1,453 2,103 1,980 2,050 2,304

Return on Invested Capital 13.2% 13.8% 16.3% 17.1% 18.3%

US Population Growth Rates

Average Yields on US Corporate Bonds

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