Almost 30 years ago, when eating organic was more "granola" than "green," Whole Foods (Nasdaq: WFMI) was a little start-up grocer espousing the importance of living a healthy, organic lifestyle.  

Whole Foods has suffered during the recession. Price-conscious customers have flocked to discount grocers like Wal-Mart (NYSE: WMT). But for the first time in a year and a half, Whole Foods reported a rise in same-store sales. Third-quarter beat expectations.

In a time when other supermarket chains have experienced shrinking profit margins, Whole Foods' has been growing larger, up to 2.3% from 1.9% last quarter. Supermarket giant Kroger (NYSE: KR) saw its profit margin drop from 2.0% to 1.9%.

Competition among conventional grocery stores is fierce. Supermarkets have cut prices to hold on to customers. And while Whole Foods witnessed a customer exodus long before other chains, it appears to have stabilized earlier also.

Now Whole Foods' shares are the top performer among grocers this year. Since the beginning of the year, Whole Foods' shares have soared +204% and are the fourth-best performer in the S&P 500.

You Are What You Eat
I like to think of Whole Foods as my friendly neighborhood grocer, a haven where I can buy healthy food grown in a healthy and humane environment.

Whole Foods CEO John Mackey feels the same way. "It's not income that drives our business," he says. "It's education. One of the reasons Whole Foods Market has held up fairly well compared to other so-called high-income retailers is because maybe we're not a high-income retailer. We're a retailer that markets to well-educated people who tend to want to continue to buy these foods regardless of the downturn."

Mackey certainly knows his customer base. People excited about organic food want everything or nothing. Sure some "organic" companies don't use chemical pesticides, but do they genetically modify their veggies? If they do, you won't find it at Whole Foods. Its standards for what qualifies as "organic" are stricter than the USDA's.

That's why, even in tough economic times, the demand is growing. Nearly half of the comments on Whole Foods' suggestion wall are from out-of-town shoppers asking for a Whole Foods in their hometown. "Please open a Whole Foods in The Woodlands!" reads one. "Come to Alabama!" reads another.

Even in 2008, the toughest year in the grocer's history, sales increased +20.6%, to $8 billion, and comparable-store sales increased 5%.

A news release from the Organic Trade Association further underlines the growing demand for organics. A recent study found that despite tough economic times, U.S. sales of organic products reached $24.6 billion in 2008, +17.1% more than the year before.

“Organic products represent value to consumers, who have shown continued resilience in seeking out these products,” said Christine Bushway, executive director of the Organic Trade Association, a business association that represents the values and development of organic retailers.

Consumers are clearly willing to pay more for the value of the food they eat. As more people understand the value of living an organic lifestyle, the demand for natural and humane products grows even larger.

According to a study from last August, 79% of consumers do not want to compromise on food quality and 70% continue to buy the same amount of natural and organic foods despite rising food prices. Overall, the survey found that 74% of adults purchase natural or organic foods. A fifth of respondents said more than 25% of all the groceries they buy were natural or organic. In addition, 66% of adults would like to find ways to buy natural or organic foods within their budget.

The reason everyone wants to go organic? Research by the Natural Marketing Institute found that the No. 1 reason people start buying organic products is because they're better for them and their families.

Regardless of what the market is doing, people will do all they can to provide healthy and safe food for their families. Whole Foods, the healthiest grocer in the country, is going to continue leading its industry. Its business model has been highly successful so far, and with fewer than 300 stores today, the company has room to grow. Strong third-quarter profits have left the company with a healthier balance sheet. And once its enthusiastic consumers have the opportunity to loosen their purse strings, their grocer dollars are going to go right back into funding healthy lifestyles, courtesy of their friendly neighborhood Whole Foods.

Who do you think is right about Whole Foods? Cast your vote now by visiting this link.

-Andy Obermueller

Whole Foods CEO John Mackey recently told the Wall Street Journal that the upscale grocer needs to change its product mix.  "We used to think it was enough just to sell healthy food," the founder and CEO said. "But we know it is not enough."

His answer: Education. He says he's going to teach Americans how to buy healthy food. Consumers, you see, cannot be trusted. "We sell all kinds of candy," Mackey said. "We sell a bunch of junk."

Really? I've always thought Whole Foods is a temple to all things good and yummy. The produce is perfect. It doesn't just sit in bins so much as it poses, waiting to be photographed and put on the cover of Ridiculously Healthy magazine. The cheese cooler is a geography lesson rivaled only by the wine aisle. The bakery is a concerto of delectability. The meat case is stuffed with prime cuts; the seafood is artfully iced, elegantly cut and ethically captured.

It is all shockingly expensive. Gourmands love it.  

Mackey, though, is tired of being the nation's destination gourmet grocer. He says he wants to return the focus to all organic, healthy foods.  

This is a terrible mistake. People don't shop at Whole Foods because they want a lecture about what they should eat. They shop at Whole Foods because they want to feel good about what they actually buy. Health may be among their concerns, but it's not the prime motivating factor. Taste is.

Mackey has noted that luxe food isn't selling like it used to anyway. Well, duh. People aren't in the same frame of mind, spending-wise, as they once were. Many consumers have traded down. Customers are opting for 99-cent macaroni instead of the $7artisan pasta. Those customers will be back when the economy rebounds. But they aren't coming back for healthy, they're coming back for quality, for perceived value they can't get elsewhere.

That being said, many Whole Foods customers don’t shop on price. And when those consumers keep coming in your stores in a recession, you've got to ask what they want. Then -- and this is crucial -- you sell them more of it. Not less. Less is crazy when more is what they're after.

Whole Foods, regardless of its roots, just isn't the neighborhood health-food store anymore. Now it's a destination retailer. It's an aspirational brand. People shop there because it makes them feel good. These customers want gourmet cooking demonstrations, sommeliers and cheese stewards. They don't want Beardo the Weirdo standing around handing out leaflets about the benefits of free-range chicken. Mackey seems more interested in social change than profits. Shareholders should object.

Mackey has the zeal of the newly converted. He lost ten pounds on a special diet that eliminated refined fats. Good for him. But now he wants to give a speech that his most valuable customers don't want to hear, much less heed. After all, people assume that everything they buy at Whole Foods is already healthy.

People aren't as ignorant as Mackey imagines. It's just that they buy what they want, not necessarily what's best for them. They don't have the discipline to follow Mackey's diet, and even if they did the last place they're going to do it is at a Whole Foods store. The current product mix there is organic, sure, but much of it isn't very healthy. And those unhealthy temptations generate a lot of revenue.

If Mackey eschews these products for purely healthier alternatives, he's going to see a net loss in revenue. And revenue in a low-ir54 business like groceries is the ball game. Mackey's not going to replace the lost revenue from the bakery or the prepared-foods section -- both tasty, neither particularly healthy -- with increased sales of organic flax seed.  

Customers say they want healthy. But they lie. They know what the right answer is. They're ready recite the standard spiel about how pesticides are from Satan and local organic is the answer. They're not going to admit they come to Whole Foods for cookies any more than they're going to tell their doctors they smoke and drink. What customers say they want isn't worth a hill of beans. What they actually buy -- now that tells you something. Face it, John: Customers like candy. They like "junk."

Whole Foods' revenue is off because of the economy -- not because it doesn't sell enough healthy food. The company is profitable because it has been smart about cutting costs. That's good management. And I admit that Mackey executed well in the downturn, getting shed of an antitrust inquiry and securing financing to continue expanding.I recommended WFMI as he did it, and pocketed a triple-digit gain.
 
Yet now that the market has made up some lost ground and the recession shows some signs of abating, Mackey seems to have lost his focus in the absence of a crisis. "Healthy eating went on at Whole Foods from at least about 1980 to 1995. Now we've had a 15-year run for the foodie philosophy. We are launching a reversal now. We will be moving into food as health."

That fifteen-year run meant a +931% total return for Whole Foods. What you did worked. no money in educating shoppers. Those foodies you evidently disdain are your best customers. If you stop stocking the gourmet stuff, you're going to kill sales.

Whole Foods, at its current valuation and given its current managerial focus, isn't a buy. Thetf44ty-five percent of the company's float is already short. No surprise there: It isn't worth 50 times earnings, especially with its CEO actively looking for ways to decrease revenue.

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--Andy Obermueller

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