Can Whole Foods Market Avoid the Death Spiral?

Whole Foods Market (NASDAQ: WFM) is a grocer that is in a very risky position right now. It has expanded fast and become something of an American institution with around 431 supermarkets in the US, Canada and the United Kingdom in the process.

Yet Whole Foods is also on very shaky ground financially because it does not have that much cash. The organic reported an income of just $526 million and a free cash flow of $144 million on revenues of $15.55 billion on December 31, 2015. To make matters worse Whole Foods reported making just $974 million in cash from operations and having $809 million in cash and short-term investments.

I know margins are low in the grocery business, but these numbers look very dangerous to me. They actually remind me of the situations at Roundy’s and The Fresh Market (NASDQ: TFM), two other grocers where management sold the company to avoid the death spiral. The death spiral is what occurs when a retailer is not bringing in enough money to cover its expenses.

Can Whole Foods Avoid Roundy’s and Fresh Market’s Fate?

Roundy’s was facing losses of $8 million despite very fast growing revenues when its management team threw in the towel and sold out to Kroger (NYSE: KR) last year. The near collapse should give Whole Foods investors pause, because the Wisconsin-based grocer owns Marino’s a high-end grocer that operates in Chicagoland.

What happened at the Fresh Market should be even more worrying because that chain is little more than a clone of Whole Foods. Fresh expanded fast but the management team eventually decided to sell out to the private equity outfit Apollo Global Management for $1.36 billion in March, after rivals like Kroger and Sprouts Farmers Market (NASDAQ: SFM) said no.

Fresh collapsed even though its profit margin (4.4% on January 31, 2016) was actually higher than that at Whole Foods (3.25%) or Sprouts (3.03%). The organic grocer simply could not make money, Fresh reported a net income of $65.5 million and a free cash flow on revenues of $1.857 billion in January.

Fresh also reported $146.52 million in cash from operations and $60.84 million in cash and short term investments – which is why the management team sold out. The company was not generating enough cash to stay in operation.

Kroger is winning the Organic Grocery Wars

Whole Foods needs to start generating more cash because it is facing serious competition in the organic business. The biggest and most dangerous threat is Kroger which has $109.83 billion in revenue to play with.

Kroger has become America’s largest organic grocer it sold $11 billion worth of natural and organic food between October 2014 and October 2015. Kroger’s organic sales are now approaching all of Whole Foods revenues and make up 10% of its business according to Fortune.

If Fortune’s numbers are right Kroger’s organic and natural foods sales are now more than double than those at Whole Foods. Whole Foods sold around $4 billion worth of organics in 2014, or $7 billion less than Kroger.

The numbers tell us that the organic grocery wars could be over and Kroger has won. It already has a massive lead over Whole Foods that the smaller grocer might not be able to overcome.

Whole Foods is definitely at a disadvantage in the battle with Kroger, which has more supermarkets 1,330 before Roundy’s four brands are absorbed into the company and enough revenue to engage in deep discounting. Kroger’s markets also offer a host of amenities that Whole Foods lacks including pharmacies, banks, gas stations, dry goods and even jewelry stores.

Kroger is also expanding fast and it definitely wants a piece of Whole Foods’ action. The Cincinnati based grocery giant bought the high-end Southern Supermarket Harris Teeter and Roundy’s partially to get its hands on Marino’s. Kroger is also experimenting with a number of other high-end grocery concepts; including Main & Vine in the Seattle area.

Whole Foods Wants a Piece of Aldi’s Action

Whole Foods is trying to counter Kroger and generate more revenue by launching its own discount grocery brand 365 by Whole Foods Market. This is a no frills market with a smaller footprint, the first one is scheducled to open on May 25, in Los Angeles’s hipster mecca of Silver Lake according to The Washington Post.

The launch of 365 is apparently designed to counter Kroger and the threat from to privately held, German-owned discount grocers Aldi and Trader Joe’s. The bottom-feeding Aldi is increasing its selection of organic and natural foods, Business Insider reported. Aldi has removed a host of unpopular ingredients including synthetic colors, partially hydrogenated oils and MSG from its popular private-label products in a bid to compete with Trader Joe’s.

That should scare Whole Paycheck to death because Aldi’s prices are reportedly 30% lower than Walmart’s, Business Insider claimed. Since the private-label items constitute 90% of the stuff on Aldi’s shelves, this positions the discounter as a go-to place for affordable organic foods.

Another threat is Trader Joe’s; which like Aldi offers a limited selection of low-priced, high-quality private-label goods. Unlike the working-class Aldi, Joe’s goes after Whole Foods’ upper middle-class urban clientele with a funky demeanor and such amenities as a large selection of affordably priced wine and beer.

Whole Foods is in a Bad Place

The 365 venture shows that Whole Foods management might think the chain has reached the limits of expansion. It has to move in different directions simply to generate enough cash to survive.

To generate the kind of cash flow it will need to survive and expand into the grocery big leagues Whole Foods will need a major success at 365. If the 365 concept is not successful, Whole Foods could be facing the death spiral at some point in the near future.

Investors should stay away from Whole Foods because this grocer lacks the resources to compete in a big way. Instead if you’re looking for a high-end grocer to invest in check out Kroger because it is cheap, shares of the grocery giant were trading at $37.99 at the close business on April 8.

More importantly, Kroger has reported 49 quarters of same store growth as of second quarter 2016. One has to wonder how Whole Foods is supposed to be able to compete with that.