Whole Foods Market: Like Starbucks, Hit by Slowing Economy, Increased Competition

Whole Foods (WFMI) released results and profit fell 13%, proving again, like Starbucks' (SBUX) results, that consumers will go for the less expensive option for like items.

Whole Foods reported results for the 12-week second quarter ended April 13, 2008. Sales increased 27.6% to approximately $1.9 billion. Identical same store sales increased 5.1%. Net income was approximately $40.0 million, and diluted earnings per share were $0.29 (vs 32 cents a year earlier). The Company estimates the negative impact on net income from Wild Oats was approximately $8.6 million, or $0.06 per diluted share, in the quarter.

In February I said,

The stock now sits just above its 52 week low and is still trading at an excessive premium to earnings. With organic food being found at about every grocer, including club stores like Costco (COST), BJ's (BJ) and Wal-Mart's (WMT) Sam's Club, a pinched consumer is far less likely to visit Macke's locations.

Since then things have deteriorated further for shareholders. The stock now trades 30% lower at Oct. 2003 levels as sales growth has slowed. While the company backed its same store sales number of 7.5% to 9.5%, given results to date, one has to think that will turn out to be way too optimistic.

Like Starbucks, Whole Foods is being hit by a slowing economy and increased competition. Both, unfortunately, are not reacting to it and actually seem to be denying the effect of competitors, preferring instead to focus on macro conditions.

The problem is that growth slowed for both retailers before macro conditions deteriorated. One can only assume that it was because customers we able to find organic meat, eggs and juices at their local markets and rather than make the trip to pay premium prices, chose "the same for less".

On the earnings call CEO Mackey said:

Results varied based on many factors including differing degrees of cannibalization from new stores, competition, and changes in the economy, making it hard to attribute our performance to one factor over another. We do believe we have experienced a greater amount of cannibalization this year related to the acceleration in our new store openings.

Now, while all of these are true, pricing is still a huge issue with now more price conscious consumers. Yet, this was not addressed.

It is also a bit bothersome that the company is still focusing on "results excluding Wild Oats". When will this stop? It is yours now and the argument can be made that you did not need to buy it, stop telling us that "without it things would be better". Shouldn't the argument you be making is that "because of it things are better"? You own it, stop trying to exclude it.

Here is the good news for investors. Unlike Starbucks, Whole Foods seems to be far more forthcoming with investors, even if one could argue with its conclusions. Also, it does have a far more diverse product mix that is not as easily copied like Starbucks'.

Are shares a buy now? Not yet. Even now shares still trade at 24 times current years earnings that are falling. If you think the economy will be stagnant for a while (I do) then that number will have to fall, much farther. Another bad quarter ought to lead to full year downward revisions and another buzz cut to the share price. I can envision this thing dropping to a mid teen PE which means a high teen share price.

Only then does it get interesting.

Disclosure: No position.

Comments

[BrotherMaynard]

You're a total hack. WFMI can't open stores fast enough...sbux can't close them fast enough. The ROIC economics of WFMI is a multiple of SBUX. WFMI has 270 stores...SBUX has 8,500.

In addition, Whole Foods' eps "shortfall" had nothing to do with a weakening consumer. It costs money to rebrand and build stores...esp after a merger.

6.7% average total comps vs sbux -1% doesn't compare either...in addition, wfmi's 24.3% comps for stores 2 years and younger were higher than the 2001 recession which showed about 22% comps.

WFMI spends 75% of their cash flow on new stores. If they stopped opening stores and started returning cash to shareholders (who probably couldn't imagine getting a 30% return on their capital), the stock would be a multiple of where it is now.

Your analysis is consensus...nobody ever made any money being consensus.

[todd su]

thank you for the insult...

the problem with 6% comps is that you are paying 26 times EPS for shares

as for the "no one ever made money", had you shorted it after my first post when I said this would happen you would be sitting on a 30% gain in 3 months

what is your idea of making $$?

PS... i also said this last may here: valueplays.blogspot.co...

the stock was $45 then...

[todd su]

thank you for the insult...

the problem with 6% comps is that you are paying 26 times EPS for shares

as for the "no one ever made money", had you shorted it after my first post when I said this would happen you would be sitting on a 30% gain in 3 months

what is your idea of making $$?

PS... i also said this last may here: valueplays.blogspot.co...

the stock was $45 then...

[BrotherMaynard]

Lowe’s expects same-store sales to drop 6%-7% for the year –lowes trades at 0.75x sales

SBUX expects SSS to be flat to negative - SBUX trades at 1.23x sales

WFMI expects same store sales to rise 7-9% for this year – WFMI trades at 0.56x sales

In addition, 20% of WFMI's float is short, WFMI from 45 to 28 was a momentum trade and therefore your analysis duplicative of a cursory glance at yahoo finance.

Stop claiming anybody made 30% on your post...especially if you're not gonna provide any audited numbers or attribution for anything else.


This site is a perennial hack-fest.

[Itsonlymoney]

Lets stay calm please. Whole foods continues to offer a unique grocery experience to a select group of customers who want clean unadulterated food and are willing to buy, yes at a premium, into a method of farming that is sustainable and non toxic. We better all hope that this trend in eating continues to advance. I am betting that this customer will stick even as money becomes tighter because there is a belief system behind their purchasing and WalMart will never be the alternative for organic food for this customer. That being said Whole Foods can still do a better job with store brands to keep prices lower. If same store sales are still climbing can we still claim that customers are trading down?

[kowalski]

"I can envision this thing dropping to a mid teen PE which means a high teen share price."

*

A share price below 20 would translate into a price-sales-ratio of less than 0.31x [based on 1yr projected sales 9200 mio, float 140.6 million shares] and a dividend yield of more than 4%.

I cannot see this happening.

*

My market opinion:

I do think some large investors have established substantial positions on the 14th / 15th [more than 30 million shares traded].

I see the downside to be contained [not lower than 26].

I actually think the stock is 'cheap' at prices below 29.

--- Profits are artificially depressed, because of massive up-front investments; under current (negative) economical conditions investors are overly cautious in their estimate of projected ROI; here lies the opportunity for long term investors!!! ---

[dondon]

WFMI may be opening too many stores too fast. On Maui, WFMI is opening a store in an odd location. It will be one of the first stores opened in an industrial area whose nearby population is economically strained (fixed income) and not familiar with natural foods and organics (local Japanese/Hawaiian, Philipino and Hawaiian). With a slew of natural foods stores located on Maui, along with three large grocery chains (Safeway, Foodland and Star Market), the slice of the pie they will grab will be smaller than expected. Costco and Walmart will also dent the ability of Whole Foods Maui to make a profit.

Opening new stores is how to grow the business, but opening stores for the sake of opening stores and not paying attention to the demographics is a sure fire way to end up like Starbucks. I actually think the Maui store and the Basalt, Co (Aspen) store are examples of Mackey opening stores just to say he has a store on Maui and Aspen.

[kowalski]

"WFMI may be opening too many stores too fast. On Maui, WFMI is opening a store in an odd location."

*

The Maui store is going to be (very) small [= only 27,000 sq. ft.]; WF is probably testing market acceptance in less than optimal locations.

*

" the Basalt, Co (Aspen) store..."

What is wrong with this medium size store [= 44,000 sq. ft]? As far as I can tell, it's a small, but rich town with lots of tourism. Why should there be not a WF store?

"The median income for a household in the town was $67,200, and the median income for a family was $73,375." [source: en.wikipedia.org/wiki/...]

[BrotherMaynard]

WFMI doesn't just open new WFMI stores next to WMT and TGT's in the hopes of generating foot traffic by virtue of their proximity. In fact, quite the opposite. Mackey consistently reiterates (on CC's) that they locate their stores in the middle of cities that have a disproportionate number of secondarily educated people. WFMI's core market is the people that skip going to the movies in favor of eating healthy. Obviously, eating healthy doesn't have immediate consequences and therefore to the common shopper eating healthy seems too abstract a thing to even bother with. No offense to anyone, but they're not going set up shop right outside of 8 mile Trailerpark for the sake of generating sales. WFMI is far from that point of saturation...and that, contrary to SBUX, of course.

[billddrummer]

Before writing off WFMI, I'd like to relate something the company did intelligently in Northern NV.

Originally, WFMI was going to open its first store in Reno in a space vacated by a consumer electronics store. (Reno had a Wild Oats less than a mile from this location.) When the merger was announced, WFMI cancelled the first lease commitment, leased another space closer to the existing Wild Oats store, retained all the employees, and opened their new store.

From a purely observational standpoint, the move made sense on several levels: Since the new location was closer to the existing store, regular clientele didn't have to relearn a route to the store. By keeping existing employees, WFMI promoted consistency and continuity with the community. And the new location is better (visibility, traffic count) than either the old Wild Oats store or the initial WFMI space.

I don't know whether the company is any good, but 24x earnings seems expensive to me. Having said that, I don't think that there will be revenue erosion from the merger in Reno because of the way WFMI went about absorbing the Wild Oats store here.

Whether that strategy has been applied elsewhere is anyone's guess. But from management's statements, it sounds like this situation was the exception, not the rule.

[ChristosAndrews]

I work for that WFM mentioned above in Reno. Our opening day is Wednesday (3 days away), and we actually closed the old Wild Oats building just today. I can tell you that the pricing situation has just recently gotten much better. We did a thorough price match with Trader Joe's, so literally, you CAN'T buy anything cheaper at TJ's than you can at WFM, even private label comparisons.
We had a pre-opening farmer's market in the parking lot today, and it had a massive turn-out, almost 3x what I expected. Because of that excitement of everyone there just for the pre-opening, I can't imagine how great business will be for us. When it was originally built, one of the intentions of building a large intricate WFM in Reno is to get people to travel to come see it, but with gas approaching $5 a gallon, who knows if that will be a good demographic for us. I was very weary opening up a store that size with that many employees in such an isolated, relatively-small city, but I think it will turn out better than I originally thought. Same goes for the Hawaii location...it's a small test market, not a full-blown luxury store, and I imagine they keep the tourism as a strong factor in this.

And as for the stock (one reason I was worried), I think a lot of it has to do with Wild Oats. I can personally say that our consumer base is continuing to grow, but rebranding and relocating so much in one year can cost a lot of money, especially since so much of WFMI's income is recirculated into the company for such things, so they aren't afraid to binge on it. WFMI continues to grow, and I firmly believe that given a year or two, the profits will be more than made up for.

[billddrummer]

Cristos,

I look forward to visiting the new store. My office is within walking distance!