Whole Foods Markets (WFM)

[DewDiligence]

The premise of the WSJ article is simple but often overlooked: older
stores, which are substantially more profitable than newer stores,
will have an increasing weight in the company’s portfolio. I think WFMI
lowballed its FY2010 EPS guidance and will end up beating it easily.

›Putting Whole Foods on Your Shopping List

FEBRUARY 8, 2010
By JOHN JANNARONE

Like a resolution to get healthier, taking a bet on Whole Foods Market has become all too easy to put off.

Little has gone right for the natural-foods company since 2006, when investors realized it was over-expanding. By the time the recession struck, Whole Foods couldn't hit the brakes fast enough. After a rally, the stock is still down 66% from its high.

Recent signals suggest it is on the road to recovery. Even with unemployment around 10%, customer traffic rose during the September quarter and comparable-store sales finally turned positive in the following weeks.

Whole Foods has advantages that could keep the momentum going. First, it learned a painful lesson that taught it to scale back ahead of many retailers. Edward Aaron of RBC Capital Markets says the company increased square footage by about 14% annually since listing in 1992 but has reduced the rate more recently to 7%.

How does that help? The company's average store, currently 7.4 years old, will be about 8.5 years old by the end of 2012, Mr. Aaron estimates. Between 2005 and 2008, the average store's age largely held steady. Mature stores are more profitable and should lift the firm's operating margin from current levels around 3.5%.

True, older locations have slower revenue growth. But the company is still adding enough new stores to keep revenue healthy. Other retailers such as Starbucks have slashed store growth far more drastically.

Investors might be troubled that Whole Foods trades at 23 times consensus earnings for calendar 2010, higher than most retailers. Yet that metric reflects large expenses from the company's building boom. Depreciation cut the company's net income in half last fiscal year, to $147 million from about $303 million. With a slower rate of store expansion, rising earnings from existing locations should outweigh more of those costs over time.

Indeed, Whole Foods has an enterprise value of 6.3 times consensus earnings before interest, taxes, depreciation and amortization. Starbucks trades at 8.2 times. Don't invest your whole paycheck, but at that price the food retailer is worth adding to your list.‹