Whole Foods Maintains Neutral Rec

Being one of the leading natural and organic foods supermarkets, Whole Foods Market Inc. ( WFM - Analyst Report ) with a strong brand image along with 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

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%.

Moreover, 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 steady in opening new stores, having opened 15 and 16 stores, respectively in fiscal 2009 and 2010, and 18 stores in fiscal 2011. Whole Foods hinted that it wants to accelerate its pace of store openings in the coming years with current plans being 24 to 27 new stores to be opened in 2012 and 28 to 32 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 significant free cash and making prudent capital investments. The company’s strong liquidity, positions it to drive future growth. During second-quarter 2012, the company generated cash flow from operations of $255.8 million and incurred capital expenditures of $101.9 million, resulting in free cash flow of $153.9 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 second-quarter 2012 results on the back of strong sales (as shoppers flocked to the grocery chain) prompted management to provide an upbeat outlook. Quarterly earnings of 64 cents a share beat the Zacks Consensus Estimate of 59 cents, and jumped 25.5% from 51 cents earned in the prior-year quarter.

Whole Foods now expects an increase of 14.8–15.6% in total sales, underpinned by expectations of an 8.2–8.9% rise in comparable-store sales and a 7.8–8.6% growth in identical-store sales in fiscal 2012.

Earlier, Whole Foods had projected a 13.5–15% increase in total sales, driven by expectations of a 7.3–8.8% rise in comparable-store sales and 7%-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 between $2.44 and $2.47 per share for fiscal 2012, reflecting a year-over-year growth of 26% to 28%. Analysts polled by Zacks, estimate fiscal 2012 earnings at $2.46. The company had previously projected earnings in the range of $2.28 to $2.32 per share.

Concerns

Whole Foods remains concerned about the sluggish recovery in the economy with a cautious consumer spending.

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 #1 Rank that translates into a short-term Strong Buy rating.