Banc of America comments on Whole Foods (NASDAQ:WFMI) saying that while they see a number of positive catalysts over the next 12 months for WFMI including slightly better organic comps, a comp lift and accretion from the OATS purchase and a better new store pipeline, they still have concerns regarding margins.
Expenses associated with opening and operating the new large format stores have dramatically increased, helping to erode the company's operating margins over the last two quarters. At the same time, increased competition and escalating labor costs are also pressuring operating margins, none of which is likely to abate near-term.
Channel checks, including a round of store visits, leaves the firm believing that 2Q comps could run in the mid 7% range. In fact, they believe there could be as much as 100 bps of upside to their 2Q07 comp estimate of 7.0%, which would place comps at the high end of company guidance of 6.0-8.0%.
Margin deterioration should continue in 2Q, and there is some risk that it may be worse than the firm is forecasting.
Channel checks continue to point to volume and shrink issues at some new stores, however. Last quarter, the drag from new square footage was particularly acute at over $60 per sq. ft. Maintains Neutral and $45 tgt.
Notablecalls: Mixed emotions about WFMI here. I still think the company's in trouble and margins will need to come down. Competition from Kroger, Publix, and Safeway that are building their natural/organic position is not going to go away. It's becoming apparent that the OATS acquisition was a defensive one.
BAC notes senior management stressed to them the importance of not letting the Wild Oats brand get into a competitor's hands, such as those of a stronger supermarket looking for a natural/organic label to add to its portfolio. So, it looks like they were forced to buy OATS. I think that over time, WFMI will need to lower their prices and that will cut into margins.
Short-term, however, I'm somewhat encouraged by BAC's checks showing stronger than expected comp performance. Will it be enough to create some short term buy interest? I'm not really sure, as the comments on margins pretty much destroy the positivity.
WFMI 1-yr chart: