DC Advisory

Whole Foods (WFM) reported last night, missed sales and earnings estimates for their fourth quarter, lowered guidance for the next fiscal year and, worst of all, reported same store sales DOWN 0.2% when the Street was looking for positive 0.7%. Adding fuel to the bearish fire was the Company indication that comps are running down about 2% in their current quarter, and they lowered guidance for the current year to “at least $1.50″ vs. the previous $1.75. The minimum of $1.50 is based on comps will remain slightly negative in the current quarter but improve slightly over the course of the year. On the positive side, to show management confidence in the future, they announced a $1 billion share repurchase program, almost 10% of the market capitalization and increased the quarterly dividend by 4%.

We all know that Whole Foods has been the “first mover” in their space for years, has compiled a great long term record of growth, generating very high returns on equity and assets, and accomplishing all this with virtually no debt. They still generate an impressive $970 of sales per square foot, at the top of the supermarket industry. At the same time, many competitors have emerged in recent years, so WFM has been challenged to maintain their marketplace dominance. On the conference call they described numerous operating initiatives to build traffic, maintain and improve margins, and reinstate their upward earnings progression. Among other things, they have a new prototype, “365 by Whole Food Markets”, a smaller footprint, generally lower priced selections, potentially suitable for a much higher number of locations than their current standard. The first of these prototypes will open later in the current year. They have also committed to a $300 million cost saving initiative.

In terms of their financial position as they put in place the various initiatives, too numerous to mention here, they have $582 million in cash and investments on the balance sheet, they have just put in place a $500 million line of credit, have just finished a year generating $1.3 billion in EBITDA, which is not expected to decline materially, even under the worst of scenarios.

Most important to this observer is the $1 billion stock buyback, instituted at the current level of just over 7x trailing twelve month EBITDA. While lots of companies do buybacks to “return cash to shareholders”, most of the time these purchases are made to allow more stock options to be issued, and at much higher valuations than exists at WFM. An EBITDA multiple of only 7x means that this Company becomes “in play” for private equity firms at this price, obviously more so at lower prices, and even at modestly higher prices. Also important, purchasing stock at 7x EBITDA is the equivalent of “automatically” generating a 14% of capital spent, since each share bought increases the EBITDA for the remaining shares. If capital is borrowed at 4% for example, the remaining shares are getting an incremental return of 11%. This is “financial engineering” at its best, serving remaining shareholders as long as future results remain respectable.

Putting it all together, I believe there is more reward than risk imbedded in WFM stock at the current time. For those of you that would like more details, the link that follows will bring you to their most recent quarterly conference call.