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Whole Foods Retained at Neutral

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We currently maintain our long-term “Neutral” recommendation on Whole Foods Market Inc. , one of the leading natural and organic food supermarkets in Texas.

The $18.6 billion company has a strong brand image, which along with marketing and merchandising expertise enables it to offer investors one of the strongest growth profiles in the industry.

Whole Foods has been spurring sales through new store openings, acquisitions and comparable store sales growth. The company plans opening of 25 new stores in 2012, 28 to 32 stores in 2013 and 33 to 38 stores in 2014. Effective pricing strategy and concentration on value offerings also bode well for the stock. Margins are healthy and ranged within 34%-35% in the last five fiscal years. Earnings growth gets a boost from strict cost-control measures, effective inventory management and improved store-level performance.

Moreover, the company has been actively managing its cash flows, by generating significant free cash and making prudent capital investments. Cash flows are also being utilized for opening of new stores, paying down debt and returning cash to shareholders through dividends and share repurchases.

Outlook remains bright for Whole Foods, as the company expects an increase of 15.6–15.8% in total sales, underpinned by expectations of an 8.6–8.8% rise in comparable-store sales and an 8.2–8.4% growth in identical-store sales in fiscal 2012. Earnings are expected to be within $2.51 and $2.52 per share range for fiscal 2012, reflecting a year-over-year growth of 30% to 31%.

We find the company’s strong fundamentals quite compelling. Currently, the stock has a projected long-term earnings growth of 18.7%, significantly higher than the peer group average of 12%.

Despite these growth catalysts, lingering macro concerns, cautious consumer spending and the stock’s current valuation limits growth in the near term.

Whole Foods’ top-line growth faces downside risk from a shift in consumers focus from higher priced organic products to cheaper private label brands triggered by negative impacts of interest rate hikes, credit availability, unemployment levels, and high household debt levels on disposable income. To add to the peril, rising competitive pressure from The Kroger Company (KR - Free Report) and Supervalu Inc. (SVU - Free Report) is raising concerns for the stock.

Moreover, we find the company’s shares to be richly valued at the current juncture. Whole Foods currently trades at a forward P/E of 34.7x, a whopping 204.4% premium to the peer group average of 11.4x. Also, the stock reflects price-to-book ratio of 5.06 and price-to-sales ratio of 1.66, which is substantially above the peer group average of 1.53 and 0.27, respectively.

Whole Foods currently retains a Zacks #3 Rank that translates into a short-term ‘Hold’ rating.


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