Executive Summary
Whole Foods Markets at the writing of this paper was trading at $47.40 on the NASDAQ. The company has been publically traded for 22 years and has seen consistent sales growth over the last ten years averaging 12.5%. The ten year share price of the company has seen growth of +250% compared to +51% growth of the S&P 500 in the years 2003-2013 3 . It has performed better on average than the
S&P 500, making it an interesting case to examine further.
Part of what sets the company apart is its ethos and identity tied to natural and organic food options, the environment, and the well-being of employees, customers, and other stakeholders. Most of the company’s initiatives are centered on a health focus, whether it’s healthy eating, GMO food labeling, or a healthy planet. The company has carved out a space serving the health conscious customer, typically living in an urban environment. These tend to be customers with a higher level of disposable income as the company is known for having higher prices compared to many grocers.
The company has proved profitable and is performing better than the industry averages and outperforming grocery competitors like Kroger and Target. Using the WACC, free cash flows, beta estimates, and pro forma projections a valuation for the company has been determine at $15.6 billion, with 367 million shares outstanding and a share price of $43. This would be valuing the company at approximately $4 less per share than the market. The value of the market stock has risen approximately
$9 from the initial writing of this paper indicating that the original fair value of $42 was on target. The weighted average cost of capital calculated was 12.16% using a beta of 1.12. The calculated beta suggests that the company is somewhat less risky compared to the market and may perform better over time. It was assumed that company has significant growth still attainable as they see potential for four times the amount of current stores in the U.S. market. The company currently has 10 stores in development and is looking to add more. On its website, it goes as far as to invite potential landlords or business partners to contact the company if they think they have a location that would be a good fit.

Historical Overview:
Whole Foods Markets (WFM) first opened its doors in 1980 providing natural and organic foods through a small storefront in Austin, Texas. The company grew in popularity, going public in 1992. At end of fiscal year 2013 it operated 362 stores located in the U.S., Canada, and the United Kingdom. Its product mix averages about 66% perishable items and 33% non-perishable items including a line of books and clothing. The company carries approximately 21,000 SKU’s and estimates that about 30% of
WFM’s sales apart from bakery and prepared foods were organic 15 .
The company has a strong focus on natural products woven into its mission and throughout its core operating activities. Its products contain no artificial additives, sweeteners, colorings or preservatives. It perpetuates an image of being a health conscious company through initiatives like healthy eating education via in-store health centers to showcase books and answer questions about healthy eating, providing store-tours, and offering cooking classes. They are the first major food retailer in the U.S. to set a deadline for GMO labeling in its stores by 2018. All suppliers whose products contain genetically modified ingredients will be required to publish the information on their product labeling or they will not be carried. In addition to a focus on health, WFM creates goals around environmental protection and sustainability e.g. seeking to decrease energy usage by 25% per square foot by 2015 at all of their stores. They have received 19 Leadership in Energy and Environmental Design certifications by the U.S. Green Building Council for their stores 15 .
WFM’s appeal is to a health-conscious customer with a fair amount of disposable income. Stores are typically located in high-traffic shopping areas on ideal real estate sites, either free standing or in a strip. Other stores are located in dense urban mixed use environments. The company has recently been expanding its stores to include downtown sites in cities such as Detroit, New Orleans, Newark and
Chicago 15 . They are increasing options for some underserved populations like downtown Detroit. They invest in communities through partnerships with local non-profits, a loan program for its producers, and

have a goal of giving away 5% of their after tax profits as charitable donations. Through the Whole
Planet Foundation, the company partners with micro-financing institutions in locations where it sources supplies. It helps provide loans to individuals who are starting small-businesses such as raising animals, producing furniture, tailoring, or agricultural ventures. Interestingly, 88% of loan recipients were women, with estimates of one woman supporting on average a family of 6. They have done projects in
58 countries 15 .
Right away it is apparent that Whole Foods is a bit different than most corporations, it has two
Co-CEO’s, John Mackey and Walter Robb. Mackey was a co-founder of Whole Foods and Robb joined in
1991, first as a regional director and eventually becoming Co-CEO. Mackey has recently co-written a book called Conscious Capitalism sharing his experiences at WFM and outlining what he believes are the new management paradigms centered on engagement of all stakeholders and a purpose beyond shareholder wealth maximization 3 . WFM calls its employees team members and divides its stores into about 10 teams per store based on product area, encouraging many choices to be made at the store level. There is a gainsharing program and teams are given annual budgets. If teams are under-budget or their sales are higher than expected, they are given the surplus at the end of the year, helping achieve buy-in from employees. If the teams are over budget the pooling is used to cover the loss. The organization has a voluntary turnover rate of less than 10%, which is low for its industry. They have been rated one of the best 100 places to work by Forbes for 17 years in a row.
Financial Analysis:
The company’s primary growth strategy is to expand through new store openings, with 26 new stores in 2013. The company uses two sales growth measures, one for comparable stores, deemed comparable after they have been in operation just over one year after being acquired or opened, and a second measure for identical stores. Growth over the last 15 fiscal years has averaged 8.2% for comparable stores and 7.3% for identical stores 15 . The company has had relatively stable performance

over the last five years, with cost of revenue maintaining approximately the same relative percentage to sales revenue, declining from 66% in 2009 to 64% of sales in 2013, Exhibit 1.
Short-term investments increased significantly from 2011 to 2012 nearly tripling, and decreasing again in 2013, Exhibit 2. The company is increasing productive use of cash by investing in short-term investments and earning returns versus allowing cash to sit idly. Their days of cash have decreased from
20 in 2009 to 8 in 2013, consistent with an increase in short-term investments, Exhibit 4. Return on assets has improved steadily from 4% in 2009 to 10% in 2013 and so has return on equity increasing from 11% in 2009 to 20% in 2013, Exhibit 4. The improved ROA and ROE shows good signs for shareholders.
Pro-forma Projections:
Pro-forma projections began by establishing the mu and lambda parameters for the company.
At first the numbers seemed difficult to ascertain, particularly for establishing the long-term growth of the company. WFM has been around for over 35 years and has grown to 362 stores at the end of 2013.
It sees the potential for as many as 1200 Whole Foods Markets stores domestically, and more opportunities internationally 15 . The Y/Y growth rates from their quarterly income statements show that they have been growing at about 10%. There is a fair amount of seasonality in the business, as summers are typically slower and in the holiday season the company incurs other nonstandard costs. For this reason the quarterly income statement data is helpful, but taken with a grain of salt. A mu of 7 years and a lambda of 25% have been chosen, indicating the company has sometime before its transient growth tapers off to the perpetual growth rate, chosen for the model as 5%.
For estimating cost of revenue and sales, general and administrative expense, a trend on sales function was used. There are linear relationships with both of these variables in regards to sales, offering trend on sales as a convenient way to project the future costs for both figures. The number of

shares outstanding was kept constant using the last year of historical data through 2023, it is unclear how the company increases its shares outstanding and for simplicity is offered as a level projection.
At first a trend on sales function was used to estimate future cash holdings for the company, but upon further analysis it was established that no observable linear trend was present. Cash holdings are seemingly random with over $400 million of cash on hand in 2009 and $8 billion in sales, and $290 million on hand and $11.7 billion in sales in 2013, Exhibit 2. An average, approximately 9 days of sales for cash was taken for the years 2009-2013, Exhibit 6.
Receivables were estimated as days of sales multiplied by projected sales. The company is able to collect its receivables quickly, which aligns with the nature of their business. Deferred income taxes was kept as a level projection, as it is difficult to predict. Prepaid expenses was estimated using a trend on sales, as it showed a linear relationship with sales. The majority of long-term assets such as goodwill and intangible assets were kept as level projections, see Exhibit 6. Property, plant and equipment was estimated using a trend on sales intrinsically reflecting the growth in new store openings.
The statement of free cash flows was generated using historical balance sheet information and estimates from pro forma balance sheets. Share based compensation was estimated as a trend on sales, utilizing historical shared based compensation information, Exhibit 3. There is a clear link between share based compensation and sales. The company rewards team members with gainsharing and the greater the sales revenues the larger the gains to team members. Dividends were calculated as a percentage of income and 20% was chosen as a level projection. The percentage of dividends to income is seemingly sporadic with as little as 3% to as much as 92% from 2009-2013, Exhibit 20. 20% was chosen as a reasonable number in the middle of the extreme percentages.
Stock Beta:
The stock beta for the company was estimated using 10 years of S&P historical returns versus 10 years of WFM returns. The resultant graph shows a 52 week beta from 2004-2014, ranging from above

2.0 to below 0.5, Exhibit 17. An average of the results generates a beta of 1.19. A three year beta was also generated with data ranging from 2004-2014, with a more meaningful trend line seen in Exhibit 19.
The average for the three year beta was 1.12, the figure chosen for the cost of capital calculations.
Additionally, a third graph was produced showing weekly company returns versus the weekly S&P 500 weekly returns for the last two years, Exhibit 18.
Cost of Capital:
The cost of capital was estimated using net debt including short-term debt, long-term debt, and capital leases less cash and marketable securities. In the case of the company no long-term debt was shown in the historical balance sheets, Exhibit 2. Capital leases were used as an approximation for shortterm and long-term debt in the absence of either account on the balance sheets. Return on debt was assumed at 6% as a reasonable interest rate. The risk free rate used was a 10 year US treasury bond with a rate of 2.18%. For calculating the market risk premium, the market return used was a ten-year historical average on the S&P 500. The WACC determined was 12.16%
Fair Stock Value:
The fair stock value of the company was determined to be $16.6 billion, the common equity value $15.6 billion, and a fair share value of $43. The common equity value is lower than the calculated market capitalization value of $17.39 billion. The calculated fair value per share is $4 lower than the $47 market close price on 12/10/2014. Calculated estimates value the company share price lower than the market value, indicating a possible overvaluing of the company in the market.
Results:
Whole Foods Markets is doing better than industry average, Exhibit 21. Its P/E Ratio is nearly 4 times the industry average and its PEG ratio is over twice the industry average. It is ahead of other national competitors like Kroger and Target. Safeway is also doing excellent with a P/E ratio of 33.12 and
PEG ratio of 2.76, both higher than WFM’s P/E ratio of 20.72 and PEG ratio of 2, Exhibit 21. Finding information on competitors is challenging as many of them are not publicly traded such as Trader Joe’s

or Albertsons. Other local competitors in the Pacific Northwest region in particular are likely to be PCC,
Haggen, and QFC. Comparing Whole Foods to other publicly traded companies it out performs the industry average, but with some competition. It serves what has traditionally been a niche market, but attracts growing customer segments as many American becoming increasingly health conscious.
A 12% earnings growth rate has been assumed using information from Yahoo finance estimates as a guide 16 . Calculated ratios are similar to those published by Yahoo, with a slightly lower calculated
P/E ratio of 20.72 compared to 24.65 and a slightly higher calculated PEG ratio of 2 compared to 1.95,
Exhibit 12. A calculated share price of $43 versus a market price of $47 indicates that the company may be overvalued by the market. The individual difference of the two prices is only $4, but compounded by millions of shares would represent a sizeable amount of money e.g. 367 million shares multiplied by $4 equals $1.468 billion. The implications of a few dollars difference in share price is notable and worth further investigation.
Monte Carlo:
When utilizing the Monte Carlo simulation the distribution for the fair value is between $32.70 and $58.20, Exhibit 23. Both the calculated fair value of $43 and the current stock price of $47 are within the 90 th percentile of the fair value calculation. The Bayesian beta and the market beta factors had the biggest effect on the fair value per share. The cost of revenue factor, the perpetual growth factor, and the growth start factor had the next largest effects on the fair value per share.
For the WACC calculation the distribution is between 10.6% and 13.8%. The biggest factor that affected the mean distribution of the WACC is the market beta. Beta’s are subject to change depending on the stock returns of the company and can thus be quite volatile. The results of the Monte Carlo overall are interesting to look at and indicate that even with the addition of risk the company is likely to perform close to as expected.

Employee Stock Options:
The value of employee stock options was found to be $406 million. The company uses employee stock options as regular incentives at all levels of the company hierarchy. It’s a considerable amount of money, but does not have a large effect on the fair value. If there were no employee stock options the fair stock value would only increase by a dollar from $43 to $44. The employee stock option was valued using the Cox, Ross, and Rubenstein model, Exhibit 28.
Debt Financing Policy:
The company currently has no debt and it may be valuable to them to consider taking on debt. If they increase their debt it will lower the WACC for the company 13 . It was determined that the company could take on approximately $3.5 billion in debt using the standard assumption of carrying debt equal to
5 times the interest on EBIT, Exhibit 29. By taking on debt, the company could lower their WACC from
12.16% to 11.64%. The effect of a lower cost of capital on the fair value is moderate, raising the fair value from $43 a share to $46 a share, Exhibit 29.
SWOT Analysis:
Strengths: The company has a strong commitment to whole and natural foods with a loyal customer base, 7.7 million customers visit Whole Foods each week. They have a compelling identity as an organic grocer and are growing in popularity when North Americans are increasingly concerned with eating natural foods. They also maintain a do-gooder image by investing in local communities, offering a loan program to their suppliers, maintaining a commitment to GMO labeling, and efforts to ensure a slavery free supply chain. They are also supported by complementary industries such as the Health
Industry, Health Insurance Companies, and the Fitness Industry 4 . The company willing seeks out new partners and entertains solicitations as it encourages potential business partners to contact Whole foods if they have a good location available for a store.

Weaknesses: The U.S. government heavily subsidizes corn and other crop growers in the US, but does not subsidize organic farmers 4 . Non-organic farmers are able to grow their food much cheaper than organic farmers, giving them a competitive advantage. Whole Foods in addition to having a reputation as a hip grocery store is also known for being expensive referred to facetiously as “Whole
Paycheck”. The company targets a relatively small niche market and does not possess a very diverse customer base. There is also an increasing number of organic farms, but the supply chain infrastructure in its current state is insufficient to serve the needs of the entire American food system 4 . Inevitably, as the popularity of organic food grows, the supply chain infrastructure will develop as profit opportunities arise.
Opportunities: Whole Foods carries a number of private food label and health items, but could broaden its offerings even more to include other nondurables. It also has its whole trade guarantee which it can further use to certify that these items are fair trade and meet the company’s standards, thereby increasing its appeal as a “do-gooder” company. Approximately, 19% of the company sales came from perishable items in 2013 and there is room for more growth. The company should consider increasing its product offerings in the prepared food items department, as these tend to be higher margin items and popular in a world where the affluent are increasingly busy. The company can continue investigating international expansion in Europe beyond the U.K. There are other countries in the region that value the organic food movement, but the company may need to localize more and target specific population centers that can support its growth. It may do well to look for another partner to do a joint venture or find a regional grocer that it can acquire to gain market entry in new countries.
Threats: Some of their market share is being eroded away by competitors. As the organic food movement grows in North America, it provides more customers for Whole Foods, but also draws competitors who can imitate. It is now common for the neighborhood grocery store to feature an organic section. In the Pacific Northwest for example, regional grocers like Haggen carry large organic

and local food selections displayed prominently in the front of the produce section. Sometimes when a customer goes to Whole Foods they will come just for the specialty item and wait to buy the essential items somewhere less expensive 10 . Organic and specialty labeled items are not regulated by the US government and the company may find poor quality or tainted product from farmer’s who cut corners 10 .
Porter’s Five Forces:
Bargaining Power of Buyers: The bargaining power of buyers is normally considered low 14 .
Buyers pay the asking price for goods. The company targets customers who tend to be able to pay higher prices in the first place and these customers may actually be less price sensitive. It is likely that buyers who are on the margin of the target customer segment are more price sensitive and if prices are too outrageous, they may switch to another grocer.
Bargaining Power of Suppliers: Large food processors are beginning to acquire more of the small organic growers and currently, less than 1% of farmland in the US is used to grow organic food 12 .
This indicates that the buying power of larger suppliers is increasing. It may be more likely that the larger suppliers will turn to the larger retailers for their contracts instead of the company or that small organic growers may favor supplying to the larger retailers as well.
Intensity of Competition: The intensity of competition will depend on the level of commitment from the traditional retailers. If many of the traditional grocers decide to commit to the organic market there may be brutal competition for the company. The larger grocers may compete on price and the company tends to have high price premiums. This is a significant strategic concern for the company as they seek to grow and maintain their position as the 7 th largest public food retailer and largest organic foods grocer in the U.S. Moving forward they will want to examine new areas for expansion and how to diversify their risk in an increasingly competitive industry. However, Whole Foods is continuing its efforts at price reduction in order to remain competitive. It has assumed smaller margins and revenues in its future projections 5 .

Threat of New Entrants: Competition exists already in the industry i.e. wholesalers, local grocery and specialty stores, and traditional grocery chains. The threat will be from grocery store chains who increase their organic selection and offer the consumer seeking organic goods even more choices.
Some of the large grocery stores like Kroger may also have economies of scale that Whole Foods can’t compete with. Kroger is over 6 times as large with 2,419 stores compared to the WFM’s 362 stores.
Whole Foods also acquires companies in its niche market in order to grow. It may consider acquiring more up and comers to drive out competition from smaller companies. The company has launched its first national advertising campaign in an effort to generate more buzz and support its new affinity program for rollout in late 2015 5 . Perhaps, the national advertising will help to make Whole Foods more of a household name and be seen in the eyes of the consumer may be as a bigger competitor to some of the large retail chain grocery stores.
Threat of Substitute Products: There are many threats of substitute products for Whole Foods, the entire non-organic section of any grocery store is a threat to the company. It is any easy switch for customers to move to a conventional grocery with one-stop shopping, convenience, and lower prices.
Many new grocery stores are built with miniature specialty stores in their design. The creativity of competitors may undermine the need for Whole Foods.

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Exhibit 1. Historical Income Statements for Whole Foods Markets 2009-2013
Source: Morningstar

Exhibit 2. Historical Balance Sheets for Whole Foods Markets 2009-2013
Source: Morningstar

Exhibit 3. Historical Statements of Cash Flows for Whole Foods Markets 2009-2013
Source: Morningstar

Exhibit 4. Historical Activity Ratios for Whole Foods Markets 2009-2013
Source: Morningstar

Exhibit 5. Pro Forma Income Statements for Whole Foods Markets 2014-2023

Exhibit 6. Pro Forma Balance Sheets for Whole Foods Markets 2014-2023

Exhibit 7. Pro Forma Schedule of Retained Earnings for Whole Foods Markets 2014-2023

Exhibit 8. Pro Forma Activity Ratios for Whole Foods Markets 2014-2023

Exhibit 9. Free Cash Flows for Whole Foods Markets 2014-2023

Exhibit 10. Valuation Calculations for Whole Foods Markets

Exhibit 11. Quarterly Income Statements for Whole Foods Markets 2012-03 -2014-06

Exhibit 12. Market Data from Yahoo Finance for Whole Foods Markets
Source: Yahoo Finance

Exhibit 13. Total Direct and Indirect Expense versus Revenue

Exhibit 14. Calculate Betas Summary

Exhibit 15. SGA versus Revenue

Exhibit 16. Direct Cost versus Revenue

Exhibit 17. 52 Week Beta over Time 2004 – 2014

Exhibit 18. WFM Weekly Returns versus S&P 500 Returns 2012-10 - 2014-10

Exhibit 19. 3 Year Beta over Time 2004-2014

Exhibit 20. Historical Average Dividends, Dividends as a Percentage of Net Income, and Average Cash for WFM.

Exhibit 21. Calculated Valuation Ratios for Whole Foods Markets versus Competitors

Exhibit 22. Updated Value Calculations

Exhibit 23. Monte Carlo Fair Value Per Share

Exhibit 24. Monte Carlo Tornado Graph Fair Value Per Share

Exhibit 25. Monte Carlo WACC

Exhibit 26. Monte Carlo Tornado Graph WACC

Exhibit 27. Value Calculations with $3.5 Billion New Debt

Exhibit 28. Cox, Ross, and Rubenstein Model Employee Stock Options

Exhibit 29. Ability to Carry Debt