Several tier-1 firms are out with excellent comments on Whole Foods (NASDAQ:WFMI) after the co issued CQ4 results and the acquisition of one of its main competitors:
- Morgan Stanley notes that as Whole Foods has a strong track record of turning around underperforming natural foods retailers, and they see significant opportunity for both overhead cost savings and store-level productivity gains, they believe this merger will be a significant earnings driver for Whole Foods over the next several years. Using what they view as conservative cost savings and productivity gains, firm's pro forma 2008 EPS rises to $1.88 from current levels of $1.74 and pro forma 2009 rises from $2.08 to $2.37. Applying a 35x P/E, they arrive at a $66 12-month price target (35x pro forma 2008 EPS of $1.88) and an $83 2-year price target (35x pro forma 2009 EPS of $2.37).
MS believes investors who have been on the sidelines should ramp back into WFMI shares as they see a multi-year period of significant merger-related earnings growth. Rates WFMI shares Overweight.
- Goldman Sachs says that based on 1Q results alone, they believe that shares would have traded lower. Not only did EPS fall short, but pre-opening expenses will increase as the year progresses. As such, 2007 estimates may need to come down further. Thus, they believe the Oats transaction is largely responsible for the shares' 5% after-market rise. Part of this reflects potential year 2 accretion and some may be short covering since an Oats deal was unexpected. That said, given how the quarter played out and that the next several will be choppy, short covering may not be as pronounced as usual and the shares could trade lower in the intermediate term. The firm therefore maintains their Neutral rating. In their view, however, the longer-term story is intact and they would take a hard look at the shares if they fall to the low-mid $40s.
- Some of the most interesting comments come from JP Morgan saying they obviously hadn't counted on an acquisition of competitor Wild Oats by Whole Foods. Normally, they shy away from acquisitions of these sorts. Nonetheless, the potential value of this transaction is evident as WFMI attempts to acquire its largest competitor and redefine itself as a large company with $12B of sales potential. They give the company the benefit of the doubt and reiterate Overweight rating on the stock.
Given the timing, this deal is likely as much defensive as much as it is offensive. Firm likens this to Walgreens purchasing Rite Aid, or if Best Buy purchased Circuit City - both lower margin, lower productive competitors. The truth here, though, is that given the addressable market potential ($400B+ food retail sector annual sales potential) and the onslaught of competition, particularly within organics, the FTC shouldn't be an issue here, in their view. It would likely be for those other sectors. So, Whole Foods is essentially getting the opportunity to purchase its largest competitor, which operates at 49% of the sales per square foot of Whole Foods. This is where the true synergy potential is, as OATS has been a significantly mis-managed company, in their view, with clear merchandising and cultural issues. Whole Foods, on the other hand, is known for its merchandising and its culture. Both companies are non-union. This compensates for the inherent risk with the deal (as WFMI currently has a full plate with an aggressive new store development target, for them).
Due diligence of the OATS deal by WFMI lacked substance, in JPM's view. John Mackey, CEO, apparently contacted Wild Oats within the last two months. Interim CEO, Greg Mays, replaced former CEO Perry Odak on 10/25/06 (Odak resigned on 10/19/06), while the old CFO (Bob Diamond) resigned on 12/20/06. John Mackey indicated that he contacted Mays after the CFO had resigned, which implies after 12/20/06. They announced the acquisition on 2/21/07.
Ron Burkle, who owns 18% of Wild Oats, has a history of selling his companies well, a la Dominicks (to Safeway) and Fred Meyer (to Kroger).
Notablecalls: Expect to see some short covering today and over the next couple of days. In the very s-t the rug was surely pulled out from under the bears. On the other hand, WFMI now has their plate full and acquisitions almost always cause operational disruptions.