Recent 20% Share Price Drop, Modest Dividend, Store Expansion Plans, Healthy Eating Trends Favor Long-Term Success

Whole Foods plans to more than double store count from 417 to about 1,200

Smaller stores with value pricing will unlock an untapped customer base of 80 million

Second quarter sales reach new record of $3.65 billion as comparable store sales improve

Whole Foods Market Inc. (NASDAQ: WFM) is a grocery store chain that specializes in natural and organic foods, and each store has sections such as produce, meat, seafood, bakery, coffee, beer and wine, nutritional supplements and prepared foods. In addition, customers have access to books, pet products and household products. Whole Foods has 417 stores (16 million square feet in total, as of May 7, 2015). Management expects to pass the 500 store mark by FY2017 with a long-term goal of 1,200 Whole Food stores across the United States, Canada and Britain.


Shares Fall 15% on Q2 Results

As of June 5, 2015, Whole Foods shares closed at $40.18, giving the company a market capitalization of $14.40 billion. Shares are down 20% year-to-date and are close to the low of their 52-week trading range of $36.08 – $57.57. Shares have experienced significant volatility over the last 2 years, typically after announcing quarterly earnings. Whole Foods shares have a price-to-earnings ratio of 24.2x, still on the high end, on earnings of $1.66 per share.

Analysts Give Whole Foods 22% Upside Over the Next Twelve Months

RBC Capital Markets upgraded Whole Foods from a Sector Perform rating to an Outperform rating, and lowered its price target from $54 to $51 on a new store concept that will accelerate currency-neutral comparable store sales growth. Whole Foods has analyst consensus ratings of Neutral/Hold and an average price target of $49.50 which represents 22% potential off current levels. Bullish analysts have a high price target of $65 that offers 60% upside potential.


Dividends and Share Repurchases Return Value to Shareholders

On April 21, 2015, Whole Foods paid a quarterly dividend of $0.13 per share, annualized at $0.52, for a dividend yield of 1.28% and a payout ratio of 30.1%. Dividends were up 8% year-over-year. The company has paid quarterly dividends since January 2004, and has increased dividends every year for the last 3 years.


Whole Foods currently has a $1 billion share buyback program that was established on July 30, 2014. In FY2014, the company spent $578 million on share repurchases, up 362% from FY2013. Over the last 3 years, share repurchases were up 1,920%.

Effective Social Media Strategy Helps Acquire and Retain Customers

Whole Foods has successfully developed and implemented an effective social media marketing strategy to connect with its customers, and leverages the core strengths of each social media platform. Whole Foods has over 873 social channels with over 10 million followers and 15 million customer engagements. For example, on Facebook (FB) and Flipboard, the company provides product information, recipes and cooking tips that promote healthy living. The company has 3.9 million Twitter (TWTR) followers, more than the other top 5 retailers combined, and uses the platform to answer questions and converse with customers. Social media analytics company, Klout, ranked Whole Foods as the, “top grocer with the most social influence” which gives the company a significant competitive advantage in customer relations.


New Discount Grocery Stores to Serve Growing Younger Demographic

To change jocular opinion that Whole Foods requires your ‘Whole Paycheck’ and to better serve its less affluent younger shoppers, management announced plans to open discount grocery stores aimed at younger millennials. CEO Walter Robb noted that the new stores will feature streamlined design, innovative technology and a curated selection at value prices. The new stores will leverage Whole Foods’ distribution chain and require less operational overhead, and are expected to open in 2016.

Operates Mobile Grocery in Portland, OR

Whole Foods operates a mobile grocery store – My Street Grocery in the Portland, Oregon, area – to bring affordable, wholesome foods to neighborhoods with barriers such as mobility, transportation, language and cooking skills. The trolley operates at different pop-up spots four days a week.


Partnership with Instacart Gives Customers 1-Hour Delivery or Convenient Store Pickup Options

Whole Foods partnered with grocery delivery service, Instacart, to offer one-hour delivery to its customers who place grocery orders on Instacart then pick up the order at a nearby Whole Foods store. Delivery options are available in all the 15 cities that Whole Foods has operations in.


Instacart accepts Apple (AAPL) Pay and Whole Foods’ mobile application was featured as a ‘Top New Application” in Apple’s iTunes. Visitors typically spend 4.5 minutes on the mobile app and view over 10 pages of content per session. The mobile app has processed over 2 million transactions, accounts for 2% of sales, and has more Apple Pay sales and transactions than any other retailer.

Management Has Always Believed in Organic and Natural Food Movement

John Mackey has been Co-Chief Executive Officer since May 2010. Mackey co-founded the company and has been a director since 1978. Many credit him with popularizing organic and natural foods.

Walter Robb is Co-Chief Executive Officer and joined the company in 1991. He oversees operations in six of the company’s 12 regions. Robb has owned his own natural food store and also worked as a farmer. He serves on the Advisory Board of the Organic Center for Education and Promotion.

Glenda Flanagan is Chief Financial Officer, a position she has held since December 1988. Flanagan is also Secretary and Principal Accounting Officer. She has experience in public accounting, retail and business consulting.

2Q15 Sales Climb 10% to New Record of $3.65 Billion with a 3.6% Increase in Comparable Store Sales

For the twelve weeks ended April 12, 2015, Whole Foods had sales of $3.65 billion (up 10%), gross profit of $1.31 billion (up 10%), operating income of $255 million (up 11%) and net income of $158 million (up 11%), or $0.44 per share.

Sales were up on a 3.6% increase in comparable store sales with a 50 basis point impact from Easter holiday being included in the second quarter in 2015 versus the third quarter in 2014. EBITDA climbed 11.6% and operating income climbed 10.4%. Management noted that average weekly sales and gross margin are highest in 2Q and 3Q due to seasonality. Comparable store sales had a 20 basis point positive impact from the Easter shift which led to comparable store sales increasing 4.2%. Management is confident that the company’s focus on fresh and healthy foods is in sync with a broader trend towards healthy eating, and will continue to deliver higher earnings over the long run, further driven by factors such as additional stores and new, smaller format stores.


Whole Foods ended the quarter with $323 million in cash and cash equivalents, $697 million in long-term debt and $4.03 billion in total shareholders’ equity.

For FY 2015, management is targeting sales growth of 9% or more, comparable store sales growth in the low to mid single digits, 38 to 42 new store openings and an EBITDA margin of about 9% for fiscal year 2015.

Summary

Whole Foods is the leader in its category and continues to deliver solid revenue and earnings growth. The company’s long-term plan to more than double store count to 1,200 (from 417 as of June 2015) should result in economies of scale and higher margins. While Whole Foods is well positioned, it faces increasing competition as other retailers eye this high-margin category and increase specialty food offerings. In addition, the increasing shift towards healthy food habits should drive-up foot traffic at existing and new stores, and further add to revenues and earnings. Shares appear a little overpriced with a P/E ratio of 24x and could see a further correction as Wall Street heads into a seasonal summer slowdown, and a potential drop in prices over the summer could offer a compelling entry point for new investors. That said, investors looking for income and long-term capital appreciation could establish positions and ride out near-term share price volatility for future long-term gains.

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