Counters groan with creamy hunks of artisanal cheese. Medjool dates beckon amid rows of exotic fruit. Savory breads rest near fruit-drenched pastries, and prepared dishes like sesame-encrusted tuna rival what's sold in fine restaurants. Staff people smile, happy to suggest wines that go with a particular cheese, or pause to debate the virtues of peanut butter maltballs. And it's all done against a backdrop of eye-pleasing earth-toned hues and soft lighting.
This is grocery shopping? Well, not as most people know it. Austin (Tex.)-based Whole Foods Market Inc. (WFMI ) has cultivated its mystique with shoppers -- and investors -- by being anything but a regular supermarket chain. It proudly offers premium products at premium prices, and its stock trades at a multiple that can be almost triple other food retailers. At $128, it's about 42 times next year's projected earnings per share, according to Adams Harkness Inc. equity analyst Scott Van Winkle. Among the reasons: 15% same-store sales growth in an industry where the norm is closer to zero, ambitious expansion plans, and the general sense that Whole Foods is, well, special. "I keep waiting for the competition I've been hearing about," says Chief Executive John Mackey, "but nobody else is doing quite what we're doing."
He's right, in large part. While chains from Trader Joe's to Wegmans Food Markets Inc. are catering to the growing interest in organic and gourmet foods, no one has yet to match the ambience and selection of Whole Foods. Since its launch in 1980, the 176-store chain has nurtured a robust culture and cult-like following.
But the $3.9 billion company is at a critical inflection point. Not every hot retail startup is able to sustain the magic. Will Whole Foods take over the world like Starbucks (SBUX )? Or will it overexpand and cool off like, say, The Body Shop? With 65 stores in development -- most of which are significantly bigger than the older locations -- Mackey has to cope with challenges from a fragmented supply chain to new stock regulations that make it tougher to shower the once-ubiquitous stock options on employees without hurting the bottom line. Some also suspect that the brand's cachet could start to diminish as stores become more ubiquitous and copycat competitors sprout up. Despite hawking itself as "the world's leading retailer of natural and organic foods," its prepared food and many other products aren't organic. And don't even think of going there for a bag of Doritos chips.
While many analysts think the country could sustain up to 500 stores, even Mackey isn't sure at what point Whole Foods' high-end model will start to tap out. "I used to think 100 stores would saturate the market," he says. Then there is the issue of the stock price. Even if the company is "hitting on all cylinders," as Bear, Stearns & Co. (BSC ) analyst Robert Summers says Whole Foods is, the stock's giddy levels make him predict that it will underperform the broad market. After releasing its third-quarter earnings in July, Whole Foods actually sported a higher multiple than Google (GOOG ).
A BREED APART
None of those concerns deter the faithful. Consider New York opera singer Bert Boone, who gushes, "I'm addicted to the onion focaccia bread!" But Boone also exposes another potential weakness in the Whole Foods formula. For all of his enthusiasm, onion focaccia and a "few other special things" are about all he is willing to buy. In California, the chain is frequently dubbed "Whole Paycheck."
Mackey dismisses the notion that customers may start to blanch at Whole Foods' prices, especially as other options spring up, arguing that "we're selling the highest-quality food in the world." But the perception that Whole Foods is a shrine to exquisite, costly products has not diminished as the chain expands. And it's selling that food in increasingly larger stores: new locations average more than 53,000 square feet, which is about two-thirds larger than the average size of existing stores. That's a lot of space to devote to fresh sushi and earth-friendly toilet paper, especially when Whole Foods' obsession with differentiating itself from the supermarket pack means that it shuns most major brands. Larger stores will inevitably require more products, more employees, and more volume. Suddenly, Whole Foods may seem a whole lot less special. The company says bigger stores allow more room for higher-margin prepared foods.
As Whole Foods gets scale, its ability to efficiently manage distribution becomes a greater issue, too. It has 11 geographic divisions, each boasting its own president and handling its own store network. That's fine for a regional player, but a company that aspires to have $10 billion in annual sales within the next few years requires a more centralized strategy. Right now, everything from transportation to product sourcing is local. "They don't have a professional supply chain," says one consultant familiar with the company. Whole Foods is working on these logistical issues, but faces less pressure to be efficient because of premium prices. Mackey stresses that the store is not supply chain-driven. "Wal-Mart (WMT ) so much dominates the mind-set in retail," he says. "Not everyone is concerned with getting mediocre food at the lowest price."
Indeed, traditional supermarkets such as Wegmans and Roche Brothers have adapted to the growing interest in natural and organic foods and are trying to make their interiors more inviting. Farmers' markets and smaller specialty outlets are also growing. Supermarketguru.com editor Phil Lempert points out that, as far as prepared foods is concerned, Whole Foods' image is better than reality -- possibly exposing the company to a customer backlash. "If you're going to brand yourself as the country's first organic supermarket, you've got to be bulletproof," says Lempert.
A much more difficult task for a growing Whole Foods will be maintaining its unique culture which, among other things, caps the salaries of top execs at 14 times the average pay. Shateema Dillard typifies the loyalty of many workers. After two years, the Manhattan employee is a supervisor and boasts of her two stock option grants. Never mind that her investment may be worth less than $200 and she's not unionized. Dillard feels well-paid and confident that "opportunities for growth are phenomenal."
Clearly, Whole Foods is thriving in what remains a low-margin and tightly squeezed industry. It is more profitable than peers, with gross margins of 35% over the past year, vs. 24% for Kroger Co. (KR ) and 29% for Safeway Inc. (SWY ), according to market research firm Capital IQ (like BusinessWeek, a unit of The McGraw Hill Companies). But Whole Foods' valuation could prove perishable. While customers will no doubt continue to clamor for prosciutto di Parma and roasted heirloom tomatoes, they may be happy to buy such items elsewhere, too. "I come here for Tazo chai (concentrate) and the fantastic cheese," says New Yorker Jennifer Lee. But if her local market would keep those on the shelves, she says she could live without the lines at Whole Foods.
By Diane Brady in New York, with Adrienne Carter in Chicago and Sarah Lacy in San Mateo, Calif.