(Bloomberg)—The problem with Whole Foods Market Inc.’s expansion plan -- and, perhaps, its entire business model -- is epitomized by its store in a western suburb of Chicago.
The Elmhurst, Illinois, outlet looks like any other Whole Foods on the inside, with its artisan breads, exotic facial oil and quinoa. But it’s the surroundings that are the problem. It shares a parking lot with a Dress Barn, a Kmart and a Shoe Carnival (“Buy One Get One Half Off”) -- “not what we would consider high end,” as Wolfe Research analyst Scott Mushkin put it.
At a time when Whole Foods is losing shoppers to the likes of Kroger, Trader Joe’s and Wal-Mart -- as those chains crowd into the organic-food business Whole Foods helped create -- the concern that Mushkin and others on Wall Street have is that by trying to expand into hundreds of new neighborhoods, the company is targeting the wrong audience. Focus instead, they say, on the wealthy urbanites who can afford to pay $29.99 for a pound of filet mignon. “They should embrace that premium experience,” said Matt Argersinger, a portfolio manager at Motley Fool. “If they race in the opposite direction, I think it will trip them up.”
It’s already happened. Shares are down more than 50 percent since hitting a record high in 2013, around the time co-founder John Mackey declared his goal to more than triple the number of stores to 1,200. Sure, there are other problems depressing the stock -- same-store sales are sliding and profit margins are shrinking as the company offers discounts and digital coupons in a bid to shed its “Whole Paycheck” nickname -- but these are issues that outsiders worry will only get worse as the company finds itself in more and more middle-class locations.
The stock suffered a fresh drubbing on Wednesday after rival Sprouts Farmers Market Inc. cut its forecast, renewing concerns about the industry. Whole Foods fell as much as 7.2 percent to $28.49, while Sprouts tumbled 17 percent to $19.
It’s an age-old problem for retailers: How do they keep growing when they run low on suitable new locations? So far, Whole Foods insists it’s sticking to the 1,200-store target. There are signs, though, that it may be having second thoughts. Mackey recently said the company would cut back on square-footage growth in 2017 and that it’s giving more scrutiny to potential new locations. The company currently operates 435 stores in the U.S., with another 20 in the U.K. and Canada.
Some analysts say it’s just a matter of time before the 1,200-store plan is abandoned, or at least tweaked. They say it’s possible, for instance, that the expansion target will be reached by including the construction of stores in the new 365 by Whole Foods Market chain. Named for the company’s private-label brand, these stores are cheaper to build and operate and are designed to attract customers priced out of the flagships.
The first two in the chain opened recently on the West Coast, with another scheduled for this month. And in May, Whole Foods said it had renegotiated three leases in Ohio and Indiana, switching those sites to 365 stores. In all, 20 leases for 365 locations have been announced. On a recent earnings call, company executives gushed about the economics of the model.
“All of our regional presidents have gone and seen the 365 stores and are kind of electrified by some of the labor savings and some of the structural changes that we’ve done there,” David Lannon, executive vice president of operations, told analysts.
So far, Whole Foods hasn’t abandoned Mackey’s target of 1,200 stores, and has said that the number of locations for its 365 stores will push the total beyond that optimistic number. And it was only four years ago that the company said its push to add more stores would include locations in food deserts in inner-city Detroit and Chicago.
The sentiment on Wall Street is that if Whole Foods is intent on expansion by competing for budget-conscious consumers, the 365 stores, with their lower cost structure, are the right way to go. Credit Suisse Group AG analysts recently added Whole Foods to its list of top investment ideas, with a price target of $40. The analysts argue that while a basket of grocery items at Whole Foods stores they visited in three Midwestern cities cost as much as 20 percent more than a similar basket at Kroger, some of that price premium was warranted because the shopping experience at Whole Foods was better. Whole Foods’ stock has been hovering in the $30 to $31 range since the end of July.
And there are, of course, some cities and neighborhoods targeted in the expansion plan where the arrival of a Whole Foods flagship store is still a hit.
In July, the company opened a glistening 51,000-square-foot (4,700-square-meter) store in the Williamsburg neighborhood of Brooklyn, the center of New York City’s hipster community and a million miles culturally from Elmhurst, Illinois. The store features a tap room and wine bar, a food hall and a full butcher shop where whole pigs hang from the ceiling. Stylish young shoppers streamed by, picking through local cheeses and stopping at the eye-catching display of LaCroix seltzer, which has become a popular selfie backdrop.
Analysts expect the location to do well, but it’s also emblematic of the company’s need to focus on areas with the kind of upwardly mobile shoppers who don’t mind paying a little more. Swinging too far the other way, and stretching to hit an aggressive store target by trying to fight a price war with Kroger and Wal-Mart, could end up being a trap that Whole Foods can’t afford to fall into.
“There are a lot more wrong ways to do it than right ways,” said Jim Hertel, a grocery analyst at Inmar’s Willard Bishop.
© 2016 Bloomberg L.P