From a single store in Austin, Texas, in the 1980s, Whole Foods helped create the market for organic and natural produce in the US, expanding through more than a dozen acquisitions to become the nation’s biggest premium grocer.
Its prices earned it the mocking nickname “whole pay cheque” but its success in persuading consumers to pay up for produce encouraged competition, both from other specialist retailers such as Sprouts Farmers Market and from traditional supermarkets such as Kroger.
The improvements these rivals made to their offerings of fresh and organic produce have taken a toll on Whole Foods, bringing the unwelcome attention of an activist investor. After six consecutive quarters of declining same-store sales, US hedge fund Jana Partners revealed earlier this month it had built a nearly 9 per cent stake.
Jana disclosed it had put together a team of industry experts to tackle what it called the company’s “chronic underperformance”, made public an extensive list of demands, and raised the possibility of a company sale.
This week, the Financial Times revealed that at least one of Whole Foods’ rivals may be interested in such a deal.
Albertsons, the third-largest US supermarket chain behind Walmart and Kroger, is exploring a bid for Whole Foods, two people briefed on the matter said, with one adding that its private equity owner — Cerberus Capital Management — has held preliminary talks with bankers.
Analysts at Credit Suisse had already argued that a supermarket operator could be a logical buyer, though they singled out Kroger, the country’s largest pure food retailer. But many analysts also caution that Whole Foods’ near-$12bn equity value may deter bidders. It also has net debt of $327m.
From the perspective of Kroger, a merger “would marry each company’s strengths with the other’s weaknesses, unlock massive cost synergies that could reach 3 per cent of Whole Foods sales, help Kroger expand its customer base, and possibly provide the growth format it has been eager to develop,” Edward Kelly from Credit Suisse wrote in a recent note.
The natural food market that Whole Foods popularised has been an important source of growth for older rivals, whose own ranges are often at lower prices. Sales of organic food are expected to top $50bn in the US and Canada for the first time this year, accounting for 7-10 per cent of the market.
But Whole Foods has not grown with the market. Karen Short, an analyst at Barclays Capital, says Whole Foods’ recent sales decline translates to as many as 14m lost visits. “They had a chance four years ago to resurrect themselves and they’ve been wasting time for the better part of those four years,” Ms Short says.
Even including the bounce that Whole Foods shares enjoyed after news of Jana’s investment, the Texas-based grocer has lost more than 15 per cent of its equity value in four years.
By contrast, Kroger has climbed 88 per cent as it has rapidly expanded its organic and natural lines, which now generate annual sales of $16bn, overtaking Whole Foods’ total sales of $15.8bn last year.
Whether Whole Foods will agree to Jana’s demands, which range from new board appointments to a complete operational overhaul, is unknown.
Jana’s past retail investments have included Tiffany, where this year it agitated for a boardroom shake-up, Walgreens Boots Alliance and Safeway ahead of its takeover by Albertsons. With Whole Foods, Jana reversed its usual practice of negotiating behind closed doors by publishing its list of demands, an aggressive tactic suggesting it wanted other investors’ support to help give it leverage.
After the announcement Whole Foods said it welcomed a “constructive dialogue” with Jana. However, its willingness to engage will rest largely with chief executive and co-founder John Mackey.
While Whole Foods abandoned its dual-CEO structure in 2016 after six years, it still has a reputation for resisting shareholder demands such as “proxy access” reforms in 2015, to give investors the right to nominate directors. It gave in after a shareholder revolt.
Analysts note, however, that some of the demands made by Jana — which wants to remedy “suboptimal” procurement and distribution, and to revamp Whole Foods’ stores and website — overlap with steps that the retailer is starting to undertake.
Brooke Buchanan, a Whole Foods spokeswoman, said: “We are confident in the actions we are taking to position the company for continued success, and we remain open to ideas to create further value for our shareholders and all our stakeholders.”
In February, for example, Whole Foods partnered with Dunnhumby, a consumer data company, to understand its customers better and improve its pricing strategy and products. It has lagged behind competitors in introducing a loyalty programme, which it is still testing.
Whole Foods this year abandoned its aggressive 2013 target to reach 1,200 stores; it has a current store portfolio of about 460 and is closing nine stores.
Zain Akbari, an analyst at Morningstar, says Jana’s focus on operations should help Whole Foods compete better. But he says the grocer’s relatively high margins for the supermarket industry limit “opportunities for significant incremental improvement”.
Whole Foods’ margin on earnings before interest, tax and depreciation stands at 5.2 per cent compared with Kroger’s 3 per cent, Walmart’s 4.7 per cent and Sprouts’ 5.3 per cent. And Whole Foods’ margins have been shrinking as prices have been cut.
However, Burt Flickinger, managing director of SRG, a retail industry consultancy which provided due diligence to Jana, is optimistic about Whole Foods’ growth potential. Mr Flickinger, who was not speaking on Jana’s behalf, argues that the retailer’s problems are mid- rather than long-term ones.
Whole Foods’ sales per square feet last year stood at $970, and while that has been falling, it remains far higher than Kroger’s $500 and as low as $200 for some grocers, he says.
Mr Flickinger says the grocer’s potential is threefold. It has a big opportunity in converting shoppers from using the supermarket as a secondary grocery shopping destination to a primary one; its store expansion possibilities are extensive; and its retention of experienced staff from butchers to cheesemongers will win customers in the long run.
He does not rule out a sale of Whole Foods, suggesting strategic buyers could include not only Albertsons but international groups such as Metro of Germany or Wesfarmers of Australia.
Morningstar’s Mr Akbari argues that a sale may be the “best investor outcome”, estimating it could fetch a price ranging from the mid-$30s to mid-$40s a share based on recent multiples grocers have fetched. Its shares closed 0.6 per cent higher at $35.71 on Friday.
Regardless, say analysts, Whole Foods’ management needs to transition the company from its high-growth phase to one that is more stable. “Almost no retailer does that [well],” Barclays’ Ms Short says. “They end up in a transitory phase and flounder.”
Additional reporting by Jennifer Bissell and James Fontanella-Khan in New York