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Whole Foods (NASDAQ:WFMI) reported its Q207 results last night (see conference call transcript). The quarter was a disappointment on most metrics:

- Morgan Stanley notes comps, total sales, margins and EPS all came in below firm's forecast. As they believe the margin drag from the new store ramp-up could persist, they are reducing their 2007 and 2008 estimates by $0.15.

MSCO believes margin drag from the new store ramp-up was one of the primary factors behind the margin weakness in the quarter (store contribution margin down 90bps, operating margin down 121 bp). Store-level depreciation expense, which is included in direct store expenses, continues to increase as a record number of stores are added to the portfolio. Whole Foods added 6 stores this quarter vs. 3 stores a year-ago. New stores also carry higher direct store expenses versus existing stores, and accordingly, the re-acceleration of unit growth is playing a role in dragging down margins. In the past, the double digit comps may have helped mask some of the new store margin drag.

While the Whole Foods base has been showing disappointing results, they still see significant turnaround potential in the pending Wild Oats acquisition and believe this will help WFMI shares stage a recovery in the year ahead. With no news on the merger (FTC review drags on), falling earnings estimates will likely have WFMI shares down sharply in today's trading. Maintains Overweight but lowers tgt to $61 from $66.

Notablecalls: Well, I think this didn't come as a surprise to the regular readers. While the stock will open down considerably today, there are some positives:

- The comp for the 5 weeks ending with May 6th was 7.5%, suggesting a potential bounce in same store sales.

- Management indicated that it was aware that certain markets require different store sizing strategies, and stated that they were not looking to put the newer, larger footprint stores in all new markets.

WFMI's still expanding at a relatively fast pace and that's certainly one of the things hurting margin performance (the other being competition). That's something the management can control.

Also, it looks like the OATS acquisition is starting to be viewed as a catalyst for the stock. While I still view it as a forced move, one has to respect the trading dynamics.

All in all, I think WFMI's a bounce candidate below the $42 level. There was a fair amount of negativity going into the EPS release and most of the bears got proven right. Yet, the intial comp performance for the 5 weeks ending with May 6th points to a bounce of some sort. That will help the stock today.

Ideally, I'd like to see some analyst coming out with a swinging downgrade, but I don't think it will happen today. We're are more likely to get supporting comments as the stock has gotten hit badly enough already.

Update: Note that HSBC is out with a downgrade on Whole Foods (NASDAQ:WFMI), taking their rating to Underweight from Neutral. HSBC says the natural and organic grocer's gross margin trends and costs in newer stores are a concern. Tgt goes to $36 from $52.

I didn't think it would happen but here it is. WFMI looks to be heading towards the $40 levels and that's where I expect it to bounce.

See also: Whole Foods Gaps Down On Earnings: Past 'Day of' Performance

Source: Whole Foods Earnings Disappoint - Now It's a Bounce Candidate