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Being one of the leading natural and organic foods supermarkets, Whole Foods Market Inc. (WFM - Analyst Report) with a strong brand image, and marketing and merchandising expertise, offers investors one of the strongest growth profiles in the industry. The stock is poised to surge once the economy revives and demand for healthier and natural food improves.

The Driving Forces

The stringent cost-control measures, effective inventory management and improved store-level performance are driving earnings growth. Whole Foods also has been revamping its pricing strategy and concentrating more on value offerings, while maintaining healthy margins. In the last five fiscal years, gross margin has been in the range of 34% to 35%.

Whole Foods has been spurring sales through new store openings, acquisitions and comparable store sales growth. Given the fragmented food retailing industry, the company has a track record of successfully integrating regional acquisitions. The company has been gaining market share compared with other supermarket chains.

The company has been prudent in opening new stores, having opened 15 and 16 stores, respectively, in fiscal 2009 and 2010. In fiscal 2011, it opened 18 stores.

Whole Foods hinted that it wants to accelerate the pace of store openings in the coming years with current plans being 24 to 27 new stores in 2012 and 28 to 32 more stores in 2013. The company believes that there exists room for 1,000 stores in the long run, and sees expansion opportunities in Canada and the United Kingdom as well.

Active Management of Cash Flows

Whole Foods has been also actively managing its cash flows, by generating healthy free cash and making prudent capital investments. The company’s strong liquidity, positions it to drive future growth. The company during first-quarter 2012 generated cash flow from operations of $260.9 million and incurred capital expenditures of $111.3 million, resulting in free cash flow of $149.6 million.

The company has been utilizing its cash flows for the opening of stores, paying down debt and returning cash to shareholders through dividends and share repurchases.

Brighter Outlook

Whole Foods’ better-than-expected first-quarter 2012 results on the back of strong sales as shoppers flocked to the grocery chain, prompted management to provide an upbeat outlook. The quarterly earnings of 65 cents a share beat the Zacks Consensus Estimate of 60 cents, and jumped 27.5% from 51 cents earned in the prior-year quarter.

Whole Foods now expects an increase of 13.5–15% in total sales, underpinned by a 7.3–8.8% rise in comparable-store sales and a 7–8.5% growth in identical-store sales in fiscal 2012. Earlier, management had projected 13–15% increase in total sales, driven by a 6.8–8.8% rise in comparable-store sales and a 6.5–8.5% growth in identical-store sales.

Whole Foods, which competes with The Kroger Company (KR - Analyst Report)and Supervalu Inc. (SVU - Analyst Report), guided earnings in between $2.28 and $2.32 per share for fiscal 2012. The company had previously projected earnings in the range of $2.21 to $2.26 per share.

Concerns

Whole Foods remained concerned about the sluggish recovery in the economy with a cautious consumer spending, and a rise in gasoline prices.

The company’s customers remain sensitive to macroeconomic factors including interest rate hikes, credit availability, unemployment levels, and high household debt levels, which may negatively impact their disposable income triggering a shift in focus from higher priced organic products to cheaper private label brands. This may adversely affect Whole Foods’ top-line growth.

Conclusion

Currently, we maintain our long-term “Neutral” recommendation on the stock. However, Whole Foods’ strong fundamentals and favorable outlook are well defined through a Zacks #2 Rank that translates into a short-term ‘Buy’ rating.

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