A View of Whole Foods in August 2008

In August 2008 Sham Gad thought very highly of Whole Foods stock. Now that Whole Foods (WFMI) stock has reached a share price that is almost a 10 year low I am curious what Mr. Sham Gad thinks of the stock.
This is Mr. Sham's article:

Whole Foods Is Worth a Whole Lot More
By Sham Gad
RealMoney.com Contributor
8/20/2008 12:59 PM EDT
URL: http://www.thestreet.com/p/rmoney/investing/10434043.html

One of my favorite investors once remarked, "You pay an expensive price for a cheery consensus." Indeed. When is the last time you found bargain investments among today's popular investment groups? It rarely ever happens. The commodities sector is case in point. While I believe the long-term outlook for commodities is strong, that doesn't mean I would go out and quickly invest in the industry. Anyone with a pulse knows that oil prices have soared and pushed up the prices of gasoline, diesel fuel and heating oil. Largely hidden from view, however, have been steep and continuing price increases across a basket of commodities. Coal sold for about $30 a ton during 2003, and hit $139 in 2008 before slipping back a bit, tripling in 12 months. Copper went from 82 cents a pound in July 2003 to $3.72 by the end of last month, an increase of 350% over five years. The price of steel has climbed from under $240 a ton for hot-rolled steel in 2003 to $1,125 a ton last month, a fourfold rise in five years. Grain prices are no exception. U.S. corn prices jumped from $3.01 a bushel in July 2007 to $5.37 one year later. Wheat doubled from $3.05 a bushel to $6.02 over the past two years. The old adage, "what has risen shall fall and what has fallen shall again rise" rings very true in investing. Blindly investing in commodities today can lead to some very quick and painful results. Just look at a few oil companies' equity prices over the past few weeks as oil has fallen from $147 to $113 a barrel. They have fallen just as quickly. Believe it or not, some of the best opportunities today lie outside the commodities and in areas where many investors frown upon.
The Economic Case
When demand is high, prices rise; conversely when demand softens, prices fall. This principle also applies to stock prices. Right now, energy and commodity businesses are the hot topics. Unfortunately, the real money was made a few years ago when corn, wheat and coal were considered boring topics, and patient investors were picking up businesses on the cheap. Enterprising investors would be well served to look in today's orphaned sectors. Hundreds of businesses have lost 50% or more of their market valuations over the past year or two. Understand, however, that a cheap stock does not equate to an undervalued investment opportunity, and an undervalued business is not necessarily characterized by a cheap stock price. A wonderful example is Whole Foods (WFMI) .
Pricey Food, Affordable Stock
For years, I have been a big admirer of Whole Foods. The quality of the business of is evident the minute you step inside one of its stores. For years, Whole Foods was the darling of Wall Street. Between 2002 and 2006, shares leapt from $18 to nearly $80 a share, and the average annual P/E ratio was over 35. During this time, the company traded for as high as seven times book. Now, with consumers cutting back, the grocer has felt the pain. The most recent quarter's results indicate choppy waters ahead. The company lost nearly 18% of its value in a single day. Make no mistake, Whole Foods is experiencing a very tough operating environment. Management indicated as much when they announced that they would be reducing expansion plans for the rest of the year. But now, with the stock at $18, the P/E is 18, and the company sells for less than two times book value, investors are avoiding it. Yet Whole Foods is a business with a wonderful economic moat. With the sticky acquisition of Wild Oats behind it, Whole Foods has eliminated its biggest competitor. Even Wal-Mart (WMT) , with its might, has yet to do anything to damage the Whole Foods brand. As a value investor, what has me so excited about Whole Foods at the current prices is simply this: to any potential buyer, Whole Foods is worth a whole lot more than its current market value of $2.65 billion. The exact figure, no one knows; but the company's assets, brand recognition, market dominance and growth prospects all add up to something more than $3 billion. Just think of how long and expensive it would be for Wal-Mart or Kroger (KR) to build a 270-store organic food chain in some of the country's top real estate locations -- and then spending the marketing dollars to achieve the image and recognition that Whole Foods has. It won't happen for $2.65 billion. In the organic and natural foods industry, Whole Foods is the Coca-Cola (KO) : it owns the market. Markets environments like today reward the investor who can anticipate what is to come. Under a tough consumer environment, Whole Food's pricier fare looks like a suckers bet. Yet, many of its customers view their food habits as a lifestyle necessity, and are more tolerant of price changes. Besides, if conventional food prices continue to rise, the value of natural foods may look better. If you are expecting results next month or next quarter, you might not like the ones you get. But if you can analyze a business through the looking glass of a multi-year period, now is a good time to look at some quality unpopular businesses. As famed investor Shelby Davis aptly remarked, "You make your best money in bear markets, you just don't know it at the time."

At the time of publication, Gad had no positions in the stocks mentioned, although positions may change at any time. Sham Gad is the managing partner of the Gad Partners Fund, a value-centric investment partnership modeled after the original 1950s' Buffett Partnerships. Previously, Gad was a writer for The Motley Fool and a securities analyst for UAS Asset Management, a small, value-focused fund in New York City. Gad also runs a value investing blog inspired by the teachings of Benjamin Graham and Warren Buffett. Gad is working on a value investing book (title forthcoming) to be published by John Wiley and Sons in the summer of 2009. Reach Gad at sham@gadcapital.com.

Prices going up and organic / non-organic differential data.......

http://www.nytimes.com/2008/04/18/business/18organic.html?em&ex=1208664000&en=f666e740e6b9ce5a&ei=5087%0A

April 18, 2008

Sticker Shock in the Organic Aisles

By ANDREW MARTIN and KIM SEVERSON

Shoppers have long been willing to pay a premium for organic food. But how much is too much?

Rising prices for organic groceries are prompting some consumers to question their devotion to food produced without pesticides, chemical fertilizers or antibiotics. In some parts of the country, a loaf of organic bread can cost $4.50, a pound of pasta has hit $3, and organic milk is closing in on $7 a gallon.

“The prices have gotten ridiculous,” said Brenda Czarnik, who was shopping recently at a food cooperative in St. Paul.

Food prices in general have been rising, but organic food lagged somewhat behind last year because of a temporary glut of organic milk and other factors. Some grocery chains adopted private-label organic products, which are cheaper than brand products, while others hesitated to raise already high organic prices.

In recent months, however, these factors have been giving way to cost pressures in the industry. On grocery shelves across the nation, sharp price increases are taking hold.

“It’s probably the most dynamic and volatile time I’ve seen in 25 years,” said Gary Hirshberg, chief executive of Stonyfield Farm, an organic dairy business. “It’s extremely difficult to predict where it’s going.”

Organic prices are rising for many of the same reasons affecting conventional food prices: higher fuel costs, rising demand and a tight supply of the grains needed for animal feed and bakery items. In fact, demand for organic wheat, soybeans and corn is so great that farmers are receiving unheard-of prices.

But people who have to buy organic grain, from bakers and pasta makers to chicken and dairy farmers, say they are struggling to maintain profit margins, even though shoppers are paying more. The price of organic animal feed is so high that some dairy farmers have abandoned organic farming methods and others are pushing retailers to raise prices more aggressively. Several organic manufacturers worry that sales may slow as consumers cut back.

Perry Abbenante, global grocery coordinator for Whole Foods Market, said sales were strong and customer counts were up. He said it might be too soon to know how consumers would react to higher organic prices, particularly in dairy.

“Man, $6.99 for a gallon of milk is pushing it,” he said. “We have to be very careful about not pricing organics out of the market.”

Over all, grocery prices have increased about 5 percent over the last year, though some staples like conventional eggs jumped 30 percent and milk, 13 percent, according to the Consumer Price Index. That government index does not break out prices for organic food.

Organic manufacturers and retailers said prices began increasing last fall but were only now starting to spike significantly in some parts of the country. Organic milk prices declined slightly last year.

Eric Newman, vice president for sales at Organic Valley, a farmers’ cooperative that sells mostly dairy products, said a half gallon of milk cost $3.49, on average, in 2007 while a gallon cost about $6. He said he expected the average price of a half gallon to exceed $4 in the months to come, while a gallon could cost more than $7.

The average retail price for Eggland’s Best Organic eggs in 2007 ranged from $3.79 to $4.29, company officials said. So far this year, the range has risen to $4.59 to $4.99.

Organic food is typically 20 percent to 100 percent more expensive than a conventional counterpart; the gap has narrowed in recent years as discount retailers like Wal-Mart have offered organics and more private-label organic products have become available, according to the industry.

Americans spent $16.7 billion on organic food and beverages in 2006, a 126 percent increase in just five years, according to the Organic Trade Association, an industry trade group. Organic sales account for about 2.8 percent of food and beverage sales in the United States, the group says.

The United States had 4.1 million acres of organic farmland in 2005, triple the amount in 1997, according to the Department of Agriculture, which regulates the organic industry. But farmers and grain buyers say the growth of new organic acreage has slowed, falling short of rising demand and causing organic grain prices to soar.

That is partly because prices for conventional corn, soybeans and wheat are at or near records, so there is less incentive for farmers to switch to organic crops; making the switch requires a three-year transition and piles of paperwork.

“There has been no new surge of land going into organic,” said Lynn Clarkson, who buys organic grain as president of Clarkson Grain in central Illinois. “We are having to compete with this ethanol juggernaut,” he added, referring to the growing use of field corn for fuel.

Ken Cook, president of the Environmental Working Group, an environmental research organization, said conventional dairy and grain prices were so high that they were nearly rivaling prices that organic farmers receive. Organic farmers normally earn a hefty premium for raising livestock and crops without chemical fertilizer, pesticides or antibiotics.

“We may be seeing over the next few years a turnaround, where organic agriculture contracts in this country,” he said. The price of organic grain has also jumped because hundreds of dairy farmers rushed to complete their transition to organic production last year, before more stringent government regulations took effect. The influx created a temporary glut of organic milk, which suppressed prices last year, but also added to the demand — and the price — for organic animal feed. In addition, a drought last year in the Upper Midwest caused relatively poor yields for some organic crops.

Doug Hartkopf, a dairy farmer in Albion, Me., said the high feed costs forced him to stop farming organically in December.

“Instead of paying $3,000 a month, I was paying $7,000,” he said. “It was a very tough decision. It was something we had to do.”

In all, at least 25 dairy farmers in the Northeast have retired early or stopped farming organically in the last six months, said Ed Maltby, executive director of the Northeast Organic Dairy Producers Alliance. He predicted that the shifts would continue unless farmers received a price increase of about 25 percent from milk processors.

The high grain prices are squeezing more than just organic dairy farmers.

“In the last three months or four months, everyone along the chain in organic food is not making their margins,” said Bob Eberly, president of Eberly Poultry in Stevens, Pa. The cost of raising poultry has increased 16 percent in the last six months, but he said his prices had increased only 7 percent.

“In the next month or so, our customers are going to see a significant price increase,” he said. “We just have to do it.”

Some organic bakeries, meanwhile, say they, too, are struggling to pay for organic flour and grains.

Michael Girkout, president of the Alvarado Street Bakery in Petaluma, Calif., said the farmers who supply his organic grain refused to honor a two-year contract in November and demanded a steep price increase.

“They said they could not afford to sell it to us at the price they agreed to two years ago,” said Mr. Girkout, who said he had little choice but to comply given the limited supply. He raised his prices for a loaf of bread 17 percent last year, he said.

Of course, the rising price of organic feed has another side. While organic livestock farmers are struggling, farmers who grow organic grain are being paid more than ever.

Organic corn is selling for $10 a bushel, organic soybeans for about $20 a bushel, and organic wheat is priced as high as $22 a bushel, all of them at least double the price of two years ago, said Oren Holle, a grain farmer in Kansas and president of an organic farmers’ cooperative.

“It is unprecedented,” Mr. Holle said. “Nobody saw these kind of market prices coming.”

Even with those prices, though, people in the industry say fewer farmers are starting the arduous transition to organic production because they can get record prices for conventional grain. Droughts, a growing global middle class and rising demand for biofuels produced from crops are putting heavy pressure on the world’s food system, sending prices up everywhere.

In the organic industry, the question is how shoppers will react to rising prices. “It will not be at all unusual for a mom to say, ‘No matter what, I am going to buy organic milk, but you know what, I don’t need to buy the organic cold cereal because I don’t see the value in it as much,’ ” said Laurie Demeritt, president of the Hartman Group, a market research firm specializing in health and wellness research.

At the Mississippi Market Natural Foods Co-op in St. Paul, Shaun Hainey, 26, said he had quit smoking and cut back on drinking and “superfluous recreational spending, like going skiing.” But he and his wife, Cassandra Hainey, have not cut back on organic food.

“We don’t foresee a price level at which we’d stop shopping organic,” he said.

But Scott Cordes, a 33-year-old budget analyst for the city of St. Paul, has found the high prices hard to bear. He now buys conventional 1 percent milk for $4.09 rather than spending $6.99 on a gallon of organic milk. Still, he does not expect to forgo organic foods altogether.

“You have to weigh the type of food you want,” he said. “I’ll only go so far to save money.”

Christina Capecchi contributed reporting from St. Paul.