Whole Foods ‘Bullish’ as Trends Improve

AUSTIN, Texas — Whole Foods Market here said last week it believes it has turned the corner on declining financial returns, and industry analysts expressed similar, albeit guarded, optimism as well.

John Mackey, chairman and chief executive officer, told analysts during a conference call he's not sure if the uptick in the chain's financial results for the third quarter signals a significant change. “We're seeing some strengthening in our sales, but we don't know if that's driven by the economy or people feeling better, but we are certainly glad to see it after six consecutive quarters of declining comparable-store sales,” he said.

“It could be that the economy is firming up and getting better, but right now we think we're making the right decisions to benefit our long-term positioning, and we're pretty bullish.”

Walter Robb, co-president and chief operating officer, said the chain has been encouraged by the recovery in traffic, customer counts and the sequential improvements in basket size and items per basket. “Those are signs of momentum and stability, and though it's too early to call where this is going, there are a lot of encouraging signs.”

The company noted, however, that year-over-year basket size is still negative but has improved since the second quarter.

Net income for the 12-week quarter, which ended July 5, rose 26.2% to $42.8 million on a sales increase of 2% to $1.9 billion. Comparable-store sales were down 2.5%. For the 40-week period, net income fell 2.3% to $110.4 million, while sales rose 0.6% to $6.2 billion and comps dropped 3.8%.

Comps were down 2.6% in last year's third quarter and 6.4% for the 40-week period. Comps during the first four weeks of this year's fourth quarter are down 1.1%, Mackey noted.

Analysts generally tempered their praise for the company's progress with caution.

Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said in a written report that sales trends at Whole Foods appear to be slowly stabilizing, “[so] as comparisons ease going forward, sales productivity slippage should continue to lessen.”

He said Whole Foods' top-line gains resulted largely from square-footage growth of 8.5%, which was offset by a decline in identical-store sales, while the earnings upside resulted primarily from gross margin rates, which rose 78 basis points to 35.15%.

However, although gross margin and expenses “appear well controlled,” Wolf said he expects ID sales to be down more than previously anticipated.

According to Simeon Gutman, New York-based analyst for Canaccord Adams, Vancouver, British Columbia, “While ongoing improvement is likely, we are not convinced the level of revenue growth necessary to sustain the current rate of EBITDA growth will be generated. Considering that new-store openings will accelerate next year and lower expenses [from fiscal 2009] will be cycled — and considering we expect a still-tepid consumer spending backdrop — such a feat seems all the more challenging.”

Edward Aaron, a New York-based analyst for RBC Capital Markets, Montreal, wrote it “might be premature” to see a significant inflection point in Whole Foods' comps, “but it seemed clear management is seeing signs of life in its stores, [with] improving traffic trends through the quarter and evidence that trade-down is easing.”

Based on management comments, he said, “a demand recovery could be materializing. Traffic and basket trends were directionally better across the store base, and the spread between private-label growth and branded growth is narrowing, and the perimeter of the store is participating in the improved trends.”

During the conference call, Mackey said Whole Foods plans a major new initiative next year built around the theme of healthy eating education.

He said the program — emphasizing food as health rather than food as pleasure — would be tested at a group of pilot stores during the first quarter of 2010 before being rolled out “full bore” later in the year.

Mackey also said Whole Foods plans to open fewer large stores, which he noted should help boost financial returns.

“With the downturn in the economy, we haven't seen our largest stores perform at the level we had originally projected for them, which has caused us to rethink our business model, and the stores we are signing now tend to be smaller — in the range of 35,000 square feet to 45,000 square feet for the most part, which we think is our sweet spot — and though we may still sign some big stores, they'll be more rare than in previous years.”

Whole Foods has increased the productivity significantly at the acquired Wild Oats stores “and they are very profitable, and we're having great success getting volumes up,” Mackey said.

He said the sale of leases and related fixed assets for 12 operating Wild Oats stores — as required by a consent agreement with the Federal Trade Commission — is scheduled to be completed by Sept. 6, though that deadline could be extended.

“This is the final chapter in a two-year melodrama, and until those deals are done, it's business as usual at those stores. Some of them will be sold, [the sale of] some may be extended if there are bona fide offers on the table and some could return immediately back to Whole Foods.”

Mackey said Whole Foods remains proactive in its value positioning. Part of the force behind the chain's value positioning, he said, has been Whole Deal, an in-store guide that is driving basket size and items per basket. He said the average basket incorporating Whole Deal offers includes 23 items totaling $65, compared with an average basket of nine items worth $33.

Robb said improvements in Whole Foods' results followed the company's decision in the spring of 2008 to move toward value offerings, “and we did it early, we did it strong and we've done it consistently.

“It took six to nine months to get some traction on those efforts and for customers to give us credit for being more competitive and for meeting their needs in these times, and now they can see the better deals, the better pricing, the better choices, and I think that is helping to drive traffic,” said.

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