Wednesday, August 01, 2007

Whole Foods (NASDAQ:WFMI): Color on quarter

Several firms comment on Whole Foods (NASDAQ:WFMI) after the co posted quarterly profit last night that dropped less than Wall Street anticipated as same-store sales stabilized and margins improved, sending its shares up as much as 11 percent:

- Morgan Stanley expects WFMI shares to stage a relief rally as margins were not dragged down by food cost inflation as the market had feared. Management announced that it is scaling back the size of some of the stores in its pipeline, signaling that the company is imposing a more disciplined approach to how much it spends on new stores. As the firm believes 2008 could be another transition year (earnings growth less than the traditional 20% rate), and the stock is still facing uncertainty over the Wild Oats merger, they maintain their Equal-weight rating.

- Banc of America notes that while they see a number of positive catalysts over the next 12 months for WFMI including slightly better organic comps, the potential for a comp lift from the OATS purchase and a better new store pipeline, they continue to be concerned about margins. Expenses associated with opening and operating the new large format stores have increased, contributing to the erosion of the company's operating margins over the last few quarters. At the same time, more competition and escalating costs are also pressuring operating margins at older stores, none of which is likely to abate near term. They are lowering their price target by $4 to $41, or 26x CY08 estimate of $1.58, and maintaining Neutral rating.

- CIBC notes Whole Foods reported results today very close to their forecasts – a little heavy on costs but a strong gross margin performance. They would caution investors not to read too much into these. The “re-located” London store is included in the rising comp-store number, so ID’s would be a better indicator than SSS growth. They are not sure that is any sign that real ID sales have actually turned around.

Firm's impression is that Whole Foods has no fear of taking price increases to make up for any
perishables inflation that it feels. Interestingly, conventional grocers are getting squeezed as they “feather” the increases through so it is very likely that the price gap between Whole Foods and conventional chains might be growing, not shrinking. At one point, reality will have to settle in and prices will have to be adjusted downward, or at least held.

To them, the Whole Foods story was always about tremendous differentiation between its operation and the nearby substandard grocery stores. And for a decade-and-a-half, that was a great strategy. But times are changing. Over 75% of conventional grocery stores now have natural and organic sections, a large number have been re-modeled to give a better experience, and pricing is significantly lower than its been in the past ten years.

In other words, the improving conventional grocers – regardless of what the FTC says – have become more plausible competitors to Whole Foods through a sharpening of assortments, lower pricing and better physical plant. Over time, that narrowing quality gap and the increasing price gap could cause some trouble for Whole Foods. In fact, the firm believes that this creeping competition could cause Whole Foods to re-examine many parts of its business – how it prices, how it distributes, how it manages costs and how it builds stores – the very things that good grocers worry about every day.

Maintains Sector Underperformer while increasing tgt to $36 from $35.

Notablecalls: Gotta love the comments from CIBC. WFMI is being squeezed by conventional grocers. The co is trying to fight the trend by cutting costs and squeezing suppliers (hence, better margins in the s-t) but will eventually find the tire marks on its back.

I suspect many of the consumers that frequent WFMI stores are getting hit with declining house values (they feel poorer) and are simply spent up. For many, shopping at WFMI is a sign of status. Until it bends.

I've been s-t positive on WFMI in the past. Think this time I'm going to be s-t neg. While the stock was up 3 bucks in after hours action, I don't see it holding on to these gains. I just don't see how they can turn this thing around quickly enough.

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