Whole Foods Market (WFM) is on the Hedgeye Consumer Staples Best Ideas list as a LONG.

 

HEDGEYE OPINION

WFM reported 4Q16 results last night that provided the glimmer of hope that we were looking for. While deflation, competition and lackluster consumer demand remain headwinds for the company and the industry overall, WFM’s improvements to the business to offset the macro seem to be resonating with core consumers. And from a macro perspective the deflation story seems to be bottoming as well, as management commented on a relatively flat commodity environment in 4Q16 with some items being inflationary, namely farm raised salmon and a couple of produce items, with Avocados being on the top of that list.

SSS declined -2.6% in 4Q16, dragging the two-year average down 75bps sequentially to -1.4%. Breaking down the comp, transactions declined by -4.2%, representing a 150bps decline in the two-year average, while change in basket size improved to +1.6%, representing an 80bps increase in the two-year average. Although the improvement in basket size is encouraging and shows strength with their core consumer, the reduction in transactions remains troubling as their efforts have yet to make a meaningful impact on the fringe consumer. In 2017 they have much more planned from a marketing and price investment perspective and we are looking to see this number improve.

Margin performance was a highlight of this quarter as gross margins declined just 36bps to 34.1% beating consensus expectations of 33.4%. EBITDA margins were also stronger than expected coming in at 7.9% versus consensus expectations of 7.2%. Looking into next year, WFM management expects operating margin declines of up to 60bps with greater declines in the first half of the year due to higher YoY pre-opening expenses in 1Q and marketing expenses in 1Q and 2Q. EBITDA margin in FY17 is expected to be 8.2%, which is in line with current consensus estimates.

WFM also made transformative changes to their executive team, with the big news being the removal of the co-CEO structure. Walter Robb will step down as co-CEO but remain on the Board, while John Mackey will become the sole CEO of WFM. EVP and CFO Glenda Flanagan (age 62) will also be stepping down as CFO as she plans to retire at the end of the calendar year.

 

NOTABLE COMMENTARY

“We continued to make selective investments on key items to narrow pricing gaps while offering strong weekly deals, which were supported by the continuation of our enhanced ad campaign…We also successfully launched our new affinity program in the Dallas/Fort Worth metro area.” (John Mackey, WFM CEO)

HEDGEYE – Turning consumer perception is a slow process that will take time.  

“…Reduce expenses by a $300 million run rate by the end of fiscal year 2017. We are pleased to report that as of year-end, we were more than 50% of the way towards our goal. The biggest reductions to date have been achieved through various labor savings measures, including evolving our marketing and HR functions from a store to metro model, reducing buying positions as we transform purchasing operations.” (John Mackey, WFM CEO)

HEDGEYE – Cost cutting is a necessary action to offset price investments.

“We just still think it’s really too early to give long term projections on 365. Our results have been a little bit mixed, some of the results have been absolutely blowing us away and others have been a little bit less than we had hoped for, so we’re still incredibly bullish.” (John Mackey, WFM CEO)

HEDGEYE – 365 appears to need some more work before it is deemed successful.

“We’ve been continuing to expand our partnership with Instacart. A big part of the year-to-date has been around expanding zip codes in existing markets.” (Jason Buechel, WFM CIO)

HEDGEYE – Delivery is the future of food and WFM seems to have a good partner to grow with.  

 

FY17 GUIDANCE

  • Sales growth of 2.5% to 4.5%
  • Comps of -2% to 0%
  • Ending square footage growth of approximately 6%, reflecting approximately 30 new stores, including up to six relocations and four 365 stores
  • Diluted EPS of $1.42 or greater, excluding any potential share repurchases
  • EBITDA margin of approximately 8.2%
  • Capital expenditures of 4% of sales
  • ROIC of 11% or greater

 

Please call or e-mail with any questions.

Howard Penney

Managing Director

Shayne Laidlaw

Analyst