Growth Pains For Whole Foods

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Spreading the organic gospel is getting costlier for Whole Foods Markets (WFMI). The No. 1 natural and organic foods retailer announced lower quarterly earnings after the close of trading on May 9, with results hurt by a rise in pre-opening costs from the chain's stepped up new store growth program. The news sent the shares sharply lower on May 10.



The Austin [Tex.] retailer reported that sales increased 11.6% to $1.5 billion for the period, due in part to 12% growth in ending square footage and a 6.0% rise in same-store sales. But the cost of opening a record six new stores during the quarter -- a total of 15 have been launched over the last 12 months -- proved to be a drag on results. Net income dipped to $46.0 million, or 32 cents per share -- below the analyst consensus estimate of 36 cents compiled by Reuters -- from $49.7 million, or 34 cents one year earlier.



The company's growth push came at a cost. Pre-opening and relocation costs were $15.6 million, or 7 cents per share, compared to $7.3 million, or 3 cents, in the year-earlier period. Approximately $6.4 million relating to share-based compensation, pre-opening rent and accelerated depreciation was expensed for accounting purposes but was non-cash, compared to $3.9 million in the prior year.



Investors reacted to the news like they had just swallowed a rotten avocado. The shares tumbled 11.4% in morning trading May 10 to $40.58 on neatly six times their average daily trading volume. The shares touched a 52-week low of $40 during the May 10 session, quite a contrast from the high for the period of $71.30 reached exactly one year earlier.



After the recent store-opening blitz, "we are still on track to open more stores this fiscal year than we ever have, said Whole Foods CEO John Mackey in a May 9 press release. "We are very excited to see the acceleration in our new store openings materialize as some of these are incredibly exciting stores that will allow us to redefine the marketplace and further differentiate our shopping experience from other food retailers." Whole Foods now operates 194 stores. By 2010, the company's goal is to have over $12 billion in annual sales and about 300 stores.



Mackey is optimistic that the accelerated pace of openings will pay off: "We expect these new stores to be strong drivers of our future sales and earnings growth."



The company has grown by opening stores of its own and snatching up smaller rivals. In its biggest deal yet, the company announced on Feb. 22 an agreement to buy Wild Oats Markets (OATS) for around $700 million including debt, as the natural food groceries fight to defend their turf in an increasingly competitive industry. Besides formidable rivals like the natural foods grocer Trader Joe's, other big industry players like Kroger (KR), Safeway (SWY), and Wal-Mart (WMT) have piled into the organic foods scrum.



Analysts were quick to respond to the disappointing results. HSBC Securities lowered its rating on the shares to underweight from neutral and cut its price target to $36 from $52 after the news, saying both gross margin trends and costs in newer stores are of concern, according to a report by JAGNotes.



Standard & Poor's equity analyst Joseph Agnese is less bearish on Whole Foods, though he also cut his price target on the shares to $44 from $55. He expects same-store sales growth near the high end of Whole Foods' 6.0%-8.0% historical range for the rest of fiscal 2007 [ending September]. Agnese noted that the company's EPS for the quarter was 4 cents below his estimate, and with the chain's margins pressured by higher health care and workers comp expenses, he cut his fiscal 2007 EPS estimate by 10 cents to $1.37. [S&P, like BusinessWeek.com, is a unit of The McGraw-Hill Cos. (MHP).]