Caution: The author of this piece is a fond shopper of Whole Foods, however does not own any shares in the company. Tonight Whole Foods made 2 important announcements, their Q1 results and the acquisition of Wild Oats at $18.50 in cash per share, or a 18% premium. I'm quite passionate about WFMI so I thought I would do a small piece on them.
Kicking it off with the Q1 results, comp sales grew 7% in Q1. Gross profit was down 24 bps YOY. Not exactly stellar results.
WFMI indicated that the historical 34% Gross Margins should continue in the future. I find this hard to believe given that WFMI in this quarter showed direct store expenses increasing 35 basis points to 25.8 percent of sales which is higher than their five-year average. Also, WFMI on the call indicated that they are not as well known for low prices that they currently offer their customers. To quote: "While our core customers are not primarily focused on price, our price image is important in terms of appealing to a broader customer base, especially as select natural and organic products are becoming more available through various retail formats." Ok, this tells me they are still experiencing price pressures, especially from the likes of Wal-Mart who has entered the organic food market. Prices at your local Whole Foods may drop further. It's clearly becoming a very competitive market, and WMT will exert it's size/strength by lowering prices further to capture more market share.
In reference to the OATS acquisition, WFMI indicated that most acquisitions take up to two years to transition to WFMI's decentralized operations and implement their incentive programs. OATS has about 100 stores in total vs. 200 for Whole Foods. WFMI expects this acquisition to be similar and that over time will recognize significant synergies through G&A cost reductions, greater purchasing power and increased utilization of support facilities. That's fine so, investors should be dumping this stock NOW and buy it LATER. I think investors should also take interest that recently (3 months ago) the Wild Oats CFO resigned. In most cases, there is a material financial deterioration in a company's fundamentals following a CFO's departure. It is a much more robust indicator than CEO departures, which can actually be a contrarian signal.
WFMI is up 5% in after-hours on Wednesday to $48 per share. I think if the stock runs slightly higher (may even go as high as the low 50's in the coming week), I would advise investors who hold WFMI to take profits (as small as they may be given the stock is still near its 52-week low)and would rate WFMI as a HOLD at best right now, until there is clear evidence that margins improve in light of the increased pricing pressures and the time required to integrate the 2 companies. OATS and WFMI do have similar qulaity merchandise, but OATS' store formats are much smaller than the typical Whole Foods stores, and they will need to realize that a different approach in managing those locations. Whole Foods' CEO John Mackey said it best when he said on the call the next 2 quarters will be messy.
That said, long-term I think WFMI is well positioned and has a respectable CEO (who only takes $1 as a salary). Once the dust settles an entry point into the stock should offer generous long term returns. STAY ON THE SIDELINES IN THE INTERIM, and let WFMI digest OATS. There could a bit more downside for this grocer that trades at 5x Book and a 1.6x PEG ratio.
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