Table of Contents
Introduction
There can be seen dramatic raise in the grocery industry all around the world. Although the growth rate in this industry is slow in nature but the competition is fierce because of the large and consistent amount of demand by the consumers which has reduce profit margins for the businesses in such industry. Moreover, there is also a close relationship of sales and growth in grocery industry with the population rate in a country (Charles & Lee, 2016).
With the advent of new century more and more people are becoming health conscious because of that organic food is gaining more popularity as compared with conventional grocery stores and non-organic food items. Further, there are a number of food chain suppliers and retailers who are involved in capturing larger shares in the food market such as Wal-Mart in USA has obtained recognition in the conventional grocery industry. Natural grocers have also been widely use in US food industry because of more health consciousness and awareness campaigns being carried out for people to stay healthy. Another change has also been observed in the purchasing behavior of consumers because more consumers have become price conscious and prefer to have discounts on various daily consumable items.
Ethical Issue
Following case is based on Whole Foods Company which came into existence in 1978, when John Mackey as well as Renee Lawson had opened smaller organic grocer that is called SaferWay in the area of Austin, Texas. This case therefore address how the Whole Food market have strengthen its position in the organic food industry and specially the issues that came across by research analyst team of Deutsche Bank of fall in the share price of Whole Food market by 19%. Therefore, report have been prepared by the team to analyze as to what strategies are available with Whole Food market to bounce back to its previous position. Specifically, the reason behind the case analysis is to address the issue about the devaluation of company’s stock price taking into account various ratio analysis and valuation methods to arrive at conclusion.
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Analysis
Undoubtedly, Whole Food have strongly positioned itself in the food industry by gaining recognition as the leading retail business of organic and natural food. Provision of best and quality food in order to maintain the well-being and vitality of the individual’s lies within the mission of Whole Food. The strategy adopted by the Whole Food to gain recognition in the market is of high pricing as well as growth strategy. They charge premium prices for their products that is the biggest challenge for its reputation in the industry. They became first organic and natural food supermarket through its chain of stores all across the world at global level. Their strategy of growth and expansion while maintain their quality standards tends to help them a lot in gaining global recognition. Increasingly creating a chain of same standard stores with the premium prices had bring them at the height of success. Their target market was high profile people living in porch areas therefore it opened its stores in high income areas where people are more conscious about their diet.
Despite of the fact that stock prices of Whole Food had declined as compared with previous years the current market position of the whole food is still sustainable. There are still chances for Whole Food to maintain its same success along with maintaining their premium prices through considering promoting product differentiation from its competitor. Therefore, bear analyst believes reducing market share of Whole Food while bullish presented favorable arguments that validate higher stock valuation of company. Meanwhile, as per CEO, it believes in positive impact of their shift in strategic plan.
Financial ratios depict that the financial standing of the Whole Food. The trend showed that the sales growth and stores growth has increased over a period of time except 2008-2009 (period of recession) however sales growth also marginally declines in 2013 due to increase in competition. The EBITDA margin trends shown growth from recession period and still looks promising in 2013. Moreover the turnover ratio of current assets showed fluctuations in previous years but company has expected that it will be having increasing trend in coming years. Current liabilities will decline but that will be consistent in forecasted years. Further the net working capital will decline in first year off forecast but increases thereafter. Also, return on capital will increase over a period of time as in the forecast made by the Bank in its report. The financial ratios in the previous years showed that company has maintained its position despite of some fluctuations and thus have capability to sustain its position in the market in future as well.
Financial assumptions play an important role to provide an accurate forecast about the financial performance of any company (Amihud & Mendelson, 2011). The more accurate are the assumptions, the more accurate will be the results of return on capital. Assumptions regarding sales growth, profit margins as well as turnover ratios are the biggest drivers of return on capital as along with growth assumptions that can bring improvements in it if anticipated accurately.
Positive EPS of the Whole Food showed that the company has been in successful position. Moreover return on capital is also positive and increasing that is why positive ratios anticipate that company will gain successful position in the Food market.
Discounted cash flow is a technique to value the firm value by applying appropriate discount rate. Therefore, it is required to forecast free cash flows and need to find the appropriate discount rate. Forecasted income statement given for 2014 and 2015 thus using that values to calculated free cash flows. Consequently, for calculating terminal value it is assumed the sustainable growth rate is 6% as it is more realistic to assume 6% as more than 10% is not sustainable in future years as competition increases in the increases causes decline in margin thus decreasing free cash flow as well. In order to evaluate the appropriate discount rate it is need to calculate cost of equity which is use as proxy of discount rate as Whole Food has zero debt in its capital structure. To calculate cost of equity CAPM model is used where risk free is taken from exhibit 8 of case a 30 year Treasury yield and market return from US stock market for 2014 year. Moreover, beta value is taken from exhibit 5 of case than use CAPM thus discount rate 10.61%. Assumptions and DCF are presented in appendix table 1. The price per share from DCF based on assumptions is $47.77.
Using valuation multiples approach that involve the comparison of Whole Food with other companies in the same industry depicted that organic food related companies have generated more revenue as compared to whole food market. (Banz W, 2017). For multiple approach in this case EV/EBITDA is used to value the price per share of Whole Food because market value equity and debt is given for industry plays and EBITDA is also given therefore average EV/EBITDA is used to calculate the price per share of Whole Food. Referring table 2 of appendix the average EV/EBITDA of industry is 10.86 consequently, the price per share of whole food is $35.68. However, if only natural & organic companies average EV/EBITDA is used the price per share is $57.49.
The estimate from both approaches difference significantly as DCF is based on assumptions therefore changing in assumptions results in varying the value of price per share while multiple approach provide price value as per its industry standards. Although, both approach gives insight that Whole Food price should be in range of 35.68 to 57.49. Therefore, below 35.68 stock is undervalued and above 57.49 stock is overvalued.
The recommendation of Short’s that Whole Food is undervalued should only be true if it primarily relies on DCF approach however if Short’s consider the multiple approach and considered average of whole industry than he must revised the recommendation. However, if Short’s relies on just natural and organic sector of industry than he must stay on its recommendation that Whole Food is undervalued.
Conclusion
To recapitulate, Whole Food have been enjoying strong position in the industry of organic food supplies as retail business yet in the recent years the value of its stock has been reduced. Therefore to know the reason behind that analyst have performed various valuation techniques in order to forecast the trends in the market. The recommendation provided by the analysts as to the fact that the company Whole Food’s stock is undervalued is true because the discounted cash flows approach validate the analyst’s opinion.
Although the margins were lower because of the greater market opportunities and fierce competition but there are still opportunities to attain larger market share in the industry. Hence, food companies relentlessly are searching for opportunities in order achieve growth as well as improve margins. In order to compete in food industry grocers are implementing loyalty programs in order to reward repeat shoppers, as well as many are now trying to improve their in-store customer experience too.
References
- Amihud, Y. & Mendelson, 2011. Asset pricing and the bid ask spread. Journal of Financial Economics , 17(3), pp. 223-249.
- Banz W, R., 2017. The Relationship between Return and Market Value of Common Stocks. Journal of Financial Economics, 6(1), pp. 3-18.
- Charles, M. & Lee, C., 2016. A Valuation-Based Approach to the Selection of Comparable Firms. Journal of Accounting Research, 40(2), pp. 407-439.
