September 1, 2014
Investors aren’t as bullish on public retailers in the nutrition and natural products market as they were in 2013. GNC (GNC), which finished last year with a stock price above $60, is now a sub-$40 stock. In February 2014, Whole Foods Market (WFM) saw comp store sales decelerate for the first time in nearly a decade. GNC and WFM act as bellwethers for their respective categories (dietary supplements and natural & organic foods)—as they go, so go their spaces.
Competition for WFM
Competition is the name of the game this year for natural retailers, and few felt it as strongly as Whole Foods Market, the world’s largest. “Natural retailers are underperforming this year because of competitive pressure,” says Scott Van Winkle, Managing Director of Equity Research at Canaccord.
Andy Wolf of BB&T Capital Markets sees increased competition across the board: “You’ve got Trader Joe’s, Sprouts, Mariano’s in Chicago. Kroger and Safeway are growing same-store sales for natural & organic products. Warehouse and club stores are selling more natural & organic.”
This trend is, of course, a barometer for success in the overall natural products industry, which continues to experience stellar sales growth. The Great Recession is solidly lodged in the rearview mirror and consumers continue to trade up to natural & organic at retail. But for Whole Foods, this high-impact growth has created something of an identity crisis, and investors have begun to turn off. In May 2014, share prices dropped a precipitous 35% after quarterly earnings revealed that earnings per share were far below projections. Comp store sales growth fell to 5% for the year, well below the 7% to 9% it had enjoyed for several years previous.
The natural retail space has gotten much more cramped as supernaturals grow their footprints and enter public finance. While Whole Foods is still committed to opening over 1,000 stores in the U.S. (a number it augmented to 1200 recently), it faces stiff headwinds from aggressively expanding public retailers such as Sprouts (SFM), Natural Grocers by Vitamin Cottage (NGVC), and The Fresh Market (TFM).
Where WFM wins on size, these latter three retailers are winning share on identity and value proposition. Sprouts has nabbed the value-oriented natural shopper with its major point of focus—cheap produce. (Over half of Sprouts’ revenue comes from fresh produce.) Natural Grocers and Fresh Market utilize smaller store formats to position themselves as convenient, neighborhood grocers in suburban settings. Whole Foods, on the other hand, has to appeal to every natural products shopper.
Here are a few more noteworthy details on these retailers:
• Sprouts came out of Q2 2014 with 20% year-over-year growth and same-store sales up nearly 10%. The company, based in the southwest United States, opened its first stores in the Atlanta metro area.
• Natural Grocers, which traded above $40 this spring, is now a sub-$20 stock. Though it can boast nearly 50 quarters of positive comp store sales growth, it’s Q3 2014 comp performance fell to just 2%.
• Fresh Market just received an upgrade from BB&T Capital Markets. According to Wolf, despite poor performances in new store openings in urban Texas and California, the company’s renewed focus on core markets makes it a strong buy.
Mass tightens too
Kroger, Safeway and Costco are a few of the most visible mass market competitors for Whole Foods. While incremental purchases of natural & organic products won’t make a material impact on these grocery giants’ bottom lines, their combined weight has begun to impact WFM’s.
“The growth for natural & organic has been a little better in mass market,” says Wolf, with an emphasis on “little.” Grocers are simply adding natural & organic products alongside their conventional counterparts in order to nab the purchase a consumer would otherwise make on their Whole Foods trip. These incremental sales are a drop in the bucket in the scheme of mass grocers’ financials. Nevertheless, here are a few highlights of these companies’ 2014 performances to date:
• Kroger (KR), whose stock price has steadily climbed to above $50 in 2014 from a low of $35, has been on an expansion spree of late. The company announced in September a plan to hire 20,000 new supermarket associates in order to better serve its stated customer focus.
• Safeway (SWY), meanwhile, is gearing up for a buyout by AB Acquisition LLC, an affiliate of Albertsons—a deal announced in March and expected to close by the end of 2014. In the meantime, its stock has held steady at just below $35.
• Costco (COST) continues to experience comp store sales growth, both domestically and internationally. The company’s stock has traded over $100 since the beginning of 2013.
The competition among supernaturals experienced in 2014 is similar in scope to that from 2006, says Van Winkle, when Walmart attempted its first foray into the organic market and Safeway began in earnest to ramp up its O Organics private label line. WFM’s comps went negative as competition heated up, and the company responded by focusing on value, in an attempt to shed itself of its “Whole Paycheck” reputation.
Value is not so valuable a strategy for Whole Foods, however, with the ascendance of more value-focused supernaturals, such as Sprouts. On the specialty and gourmet front, there’s Trader Joe’s on the rise. On small-store formats, there’s Natural Grocers and Earth Fare.
The year of the manufacturer
While the year is shaping up as nothing special for the history books in public natural retailers, it’s really the curse of prior-year overperformance that makes the comparables less attractive. According to Wolf, we’re in an extended period of dramatic competition in natural retail, which tends to be a turnoff for investors. “It’s when competition peaks that investors want to get back in,” he says.
For natural & organic food manufacturers, distributors and suppliers, however, these are the salad days. Boulder Brands and Hain have enjoyed banner years. WhiteWave completed its $600 million acquisition of Earthbound Farms (the largest organic produce company in the U.S.) in January of this year. General Mills acquired Annie’s in September. Non-GMO soybean processor SunOpta (supplier to Hain, Boulder Brands and Whole Foods) crossed $1 billion in revenue and boasts one of the best performing stocks in the natural & organic space. UNFI, which tends to go as WFM goes, has actually outperformed its largest customer thanks to its high-growth mass market distribution business. Those who stand to gain most during this period of increased competition are young, innovative food brands. As retailers race to stand out from one another, new, high-value and differentiated products will be in large demand.
Also on the horizon for food manufacturers could be a concerted push into the food service industry. According to Van Winkle, Boulder Brands plans to announce a major partnership to sell gluten-free items through restaurants later this year. Hain, with its gluten-free offerings, could find a similar opportunity. For the retailers, expect promotional fury, cutthroat value pricing, and possible acquisitions as we move through this period of competition.
Multis, omegas & GNC
GNC experienced a much more significant shake-up than Whole Foods in 2014, with its share price dropping below $40 from a high of $60 earlier this year. Earnings per share took a two-cent dive from Wall Street consensus estimates following the company’s release of second-quarter earnings. Comp store sales also shrank to 4% in Q2, compared to nearly 7% in the previous year’s quarter.
On August 5, former Vitamin Shoppe (VSI) president & COO Michael Archbold took the reins of GNC, replacing nine-year veteran Joe Fortunato as CEO. Fortunato appears to have suffered quick reprisal from just two quarters of underperformance. “I look forward to working closely with the team across GNC and the Board to further strengthen the company’s market position and deliver improved financial performance,” says Archbold in a GNC release. Archbold has 25 years’ experience in the retail world, with executive tenures at Vitamin Shoppe, Talbot’s, Saks Fifth Avenue and AutoZone.
But most would argue that GNC’s performance hiccups are beyond the control of management. “In 2014, the broader market for supplements has softened, creating a pause in the growth cycle for what has been a very resilient sector in the past,” Fortunato said on the company’s Q2 2014 earnings call. He called out negative media, inclement weather, and a difficult new member pricing initiative as hindrances to the company’s 2014 performance.
“The culprit is multivitamins and omegas,” says Van Winkle. When negative studies surrounding these two supplement mega-categories hit media outlets last summer, retailers and manufacturers couldn’t act fast enough to stem the tide of consumers who chose to nix these products from their supplement regimens. There’s also the specter of DMAA, rogue ingredients in the sports nutrition category, and the potential reputational damage to GNC as such a major proponent of the preworkout category so often home to these products.
The year 2013 was otherwise strong financially for supplement sellers. IPOs and stock value appreciation accelerated through the first half and this acceleration kept retailers and manufacturers buoyant through the initial media wildfire. But a consistent lack of good news regarding omega and multivitamin science brought a sluggish start to 2014. NBJ continues to forecast a sales slowdown for 2014, with annual growth down from 7.5% to approximately 5%, assuming some rebound in the second half of the year.
Analysts had previously concerned themselves with finding out how GNC planned to contend with Amazon selling supplements for cheaper than GNC could compete with. Now the question is whether the supplement industry as a whole can dig itself out of a spiral of bad press.
Competitors in channel
Anxiety surrounding GNC’s future performance has some analysts chomping at the bit. Gary Balter of Credit Suisse released a report in August suggesting that GNC purchase Vitamin Shoppe. The merger makes sense from a logistical standpoint—a former VSI exec is now CEO of GNC, the companies have overlapping footprints that could easily be integrated, and the combo of websites would bolster an online play that would better rival Amazon’s ascendance.
But it also has the tenor of general Wall Street braying. Vitamin Shoppe has faced similar challenges as GNC this year, but has not suffered any precipitous declines in stock price. In Q2 2014, the company posted
weakness in its margins, with gross profit down 120 basis points. Higher consumer spending on low-margin items, growing e-commerce sales, and the effects of integrating the company’s latest acquisition, Nutri-Force, all contributed to the dip in profits.
Unlike natural & organic food retail, competitive pressures have remained fairly consistent this year, VSI executives said during their Q2 2014 earnings call. All in all, the company has maintained strong results through softness in the overall supplements market.
Competitors out of channel
C-stores, pharmacies and big box have responded to supplement softness with aggressive discounting and promotions, especially through e-commerce. According to Jack Neff of Ad Age: “The retail players gaining share—Walmart and online in particular—are more price focused, while some retailers that had backed away from deep-discount promotions, such as Walgreens, are coming back to it.”
Otherwise these retailers remain fairly insulated from weakness in the market and are free to pursue new marketing and branding techniques to take ownership of the health market—whatever that may mean. CVS has nixed cigarettes from its product line-up in order to rebrand as CVS Health. Walgreens has decided to reincorporate in the United States rather than follow the lead of several companies clambering to the tax haven of Ireland. Rite Aid acquired health coaching provider Health Dialog Services in April. All three companies are hiring health coaches, guides and nurse practitioners to walk their floors and assist consumers.
This last trend, of course, has been a hallmark of natural retailers and pharmacies for years, while attendants at GNC, Vitamin Shoppe, Vitamin World, Max Muscle, and others receive training on new products and science on a regular basis. But where these companies win in specialization and breadth of product offering, they’re beginning to lose on price and general consumer excitement.
A new omega-3?
According to Van Winkle, what the supplement industry’s really missing right now is a new breakout category, on the scale of gluten-free or non-GMO in the food market. Probiotics sales have been strong this year, as well as smaller categories such as sleep aids, mood enhancers, inflammation supplements, and, of course, protein. But the supplement industry desperately needs a new omega-3, a new billion-dollar-plus market to build some consumer excitement. Protein has supply constraints. Inflammation and brain health are risky from a regulatory perspective. Probiotics face problems of potency, consumer confusion, and scientific inconsistency. That said, supplements are a historically resilient product category—and GNC is a historically resilient company.
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