Rule #1 Finance Blog

With Investor Phil Town


There has been some interesting discussion about Whole Foods (WFMI) in the comments under my recent post. I’m reprinting one of my responses here so everyone can read why I think WFMI has a moat that won’t easily be breached.

Thanks for your viewpoint [re: WFMI’s high prices harming its ability to establish a moat against Trader Joe’s, Wild Oats, and other organics grocers], and I have to say, points well taken —
but, in my humble opinion, mistaken.  Here’s why:  WFMI is in
the brand business, not the price business.  So as long as the lines are
long, they would be nuts to start dropping prices — unless they can keep
their margins high by using their growing buying power to lower their
costs.  Which is, of course, is what they are going to do as they
get bigger. 

Right now they are only 165 stores
nation-wide. (Albertson’s has 2400 by way of
comparison.) When they get to 1000 stores, their buying leverage
will be immense compared to anyone else they compete with.  Then
you will see the others who try to compete on price fall by the
wayside.  Competing on price just sucks as a business plan.
So ‘whole paycheck’ [Whole Foods’ nickname in some areas] with long lines?  YEAH BABY!!!  That just

Trader Joe’s, by the way, has really low prices — which means they
have really low margins, which means it’s hard for them to grow quickly
and easy for them to be attacked.  At some point, they either
decide to stay small (their current plan) and not go head up
against WFMI, or, like Wild Oats, they will be crushed by a superior
product at a superior price.  Any pricing model that TJ can use,
WFMI can use better because they are much bigger.
  In the grocery
business, size is price.  (WMT vs KMART would be an apt comparison
should TJ decide to take WFMI on, and as you know, KMART is bye-bye.)
As to ‘whole paycheck’, that’s what they said when Starbucks sold
coffee for 20 times the going price — and that didn’t turn out so badly,
did it?
  John Mackey, who runs WFMI, tells a story of his startup
days to this point: He and his wife were working 80 hours a week and
taking home $200 a month.  He was roundly criticized by his hippie
friends for being too high priced.  He decided then and there to
build a business based on solid core values that included making a
solid return on invested capital.  He’s done so for the last ten
years and if he keeps up the intelligent growth, WFMI can go on this way
for my lifetime, no question.
So here’s the point:  when you are evaluating a business to
own, since you are only going to own a few great businesses, it’s
important to learn how to spot a solid Moat that is durable.
I’ve done here is tell you why I think the WFMI Moat is durable.
But that really sort of follows noticing that WFMI’s numbers scream
MOAT!  The WFMI castle has been under attack for its entire
lifetime, but the Big Five numbers tell us that the attackers aren’t
getting across the Moat. 

From that point we can dig in and see if
we can figure out what the Moat is and how durable it is.  For my
nickel, the moat is getting wider and deeper (and that’s backed up with
the Big Five getting bigger and better). 

So defining the Moat is
two parts:

  1. Do the Big Five show a durable moat?
  2. Can you figure
    out why? 

Both are important to know before we buy. 

WFMI has a brand moat that is far superior to trying to compete on
price.  Their brand includes the best staff, the best natural fast
food, the best fresh food and the best shopping environment in the
grocery buisness.  Obviously people are willing to pay for the
whole experience.  You should see the lines in the Columbus
Circle, NYC store
on Saturday night! 

Competing with this Brand on
the basis of price is suicidal.  The dying old school grocery
stores are trying to get into this business and will try to compete on
price, killing WFMI’s competitors from below while they in turn are
being eaten by WalMart from even farther below.
WFMI competes
with a branded quality experience that simply is not matched in their
industry.  That plus the best pricing model in the business is
their moat and, as I said, it’s getting wider by the day.

So now that you see how I think about it, instead of debating this
one, how about finding one that you feel this way about.  Write
me and defend your wonderful business that is available at an
attractive price, and I’ll post it here for the world to see how you go
about it.  And, believe me, since WFMI is pushing up against its
Sticker price (the time when a Rule # 1 investor gets out — temporarily), I’m looking for the next wonderful thing to put on my Watch List.
Now go play (but before you do, go find me a great Rule #1 business to buy!)