Whole Foods: Trouble & Value Both (WFMI, KR)

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Whole Foods Market, Inc. (NASDAQ: WFMI) is in an interesting spot right now.  The company’s growth has peaked for now due to the economy and a curtailing of expansion plans.  It also has some issues with its already-completed Wild Oats merger.  The company also sits in a spot of the economy where it could be vulnerable to margin pressures.  But there are some merits to WFMI as well now that the stock has come so far down.

The organic and high-end grocer lost a bid on Friday at the CircuitCourt of Appeals for the District of Columbia to review an appealscourt decision that threw into question the legality of its alreadycompleted merger with former rival Wild Oats.  Let’s forget about theramifications here for a moment and pretend that the merger falls apart.  It was not really a fair merger for the consumer,but it was completed and if this merger gets broken up then there aremany others that should be broken up as well. 

The other issue is that economy is in shambles and a court ruling ofthis sort might arguably hurt the company badly.  What if Friday’s closing price of $8.19and an intra-day low of $7.04 before the end of day rally was pricing inthe worst case scenario? 

We still argue that the market is currently unable or unwilling toprice almost anything in, but share prices are back under the lows ofMarch 2001 and are now flirting with 1999 lows.  If the stock dropsmuch more it will be back to 1995 to 1997 levels. 

We have noted over and over in the past how Kroger (NYSE: KR) hasmanaged to pull away customers from Whole Foods byoffering many competing goods or exact goods at not so "whole paycheck"prices.  This may keep price pressure on at Whole Foods and thereforeaffects its margins.  That was a longer-term issue which may not seethe same sort of leaps and bounds ahead.  But what is amazing is thatWhole Foods sales have not fallen off the proverbial cliff.  We could make the case that sales there should be off 15% to 20%or more, but that has not happened. 

And the value case here is a compelling one.  If the company comesanywhere near its projections with essentially flat sales, then thestock trades well under 10-times forward earnings.  And the growthstory is different than at traditional grocery stores.  As the economyeventually picks back up, Whole Foods should have a spring-loadedearnings benefit associated with it.  That recent $425 millioninvestment from Leonard Green & Partners, L.P. isn’t exactly a badendorsement either.

This was part our "Under $10 Stocks"newsletter which went out this weekend.  We also saw later on thatBarron’s made a value case here with one fund manager saying that innormal times this stock sale would be beyond the bottom.  At currentprices for investors who can slowly build positions for the long-termand who are not trading for the next hour’s move, we agree.

Jon C. Ogg 
November 24, 2008