Whole Foods (WFM) Q3 Earnings In Line, Outlook Subdued

After registering back-to-back earnings beat in the first two quarters of fiscal 2016, Whole Foods Market, Inc. (NASDAQ:WFM) reported in line earnings in the third quarter. This natural and organic foods supermarket chain posted quarterly earnings of 37 cents a share that met the Zacks Consensus Estimate but declined sharply from 43 cents delivered in the year-ago quarter. As a result, management provided a subdued outlook for the fourth quarter, thus causing the stock to decline 5.2% during after-market trading hours yesterday.

The company’s top line improved 2% year over year to $3,703 million in the quarter under review, and also surpassed the Zacks Consensus Estimate of $3,691 million, following a sales miss in the second quarter.

Whole Foods, which carries a Zacks Rank #4 (Sell), witnessed a 2.6% fall in comparable-store sales (comps) during the quarter, following a 3% decline in the preceding quarter. During the first three weeks of the fourth quarter of fiscal 2016, comps dropped 2.4%. Analysts believe that intense competition has been weighing upon the company’s performance.

Whole Foods has been revamping its pricing strategy and concentrating on value offerings in view of heightened competition as more companies are entering and expanding their presence in the Organic & Natural food business. These players include The Kroger Co. (NYSE:KR) , Sprouts Farmers Market, Inc. (NASDAQ:SFM) and Wal-Mart Stores Inc. (NYSE:WMT) .

We note that this Austin, TX-based company is leaving no stone unturned to reach its target customers, whether through national marketing and branding campaigns, home delivery services, store expansion, or the adoption of a digital route such as the launch of digital coupon within its Whole Foods Market mobile app. Moreover, it introduced a new “uniquely-branded store concept”, "365 by Whole Foods Market". The new chain is equipped with innovative technology, compelling products at value prices and a much modern look to target millennials and stave off competition.

With the launch of the “365” smaller format sister chain, Whole Foods intends to turn things around in its favor. However, analysts are concerned whether the new store model will prove to be a game changer and help Whole Foods retain market share amid stiff competition without cannibalizing its own business.

For quite some time now, Whole Foods has been working on lowering prices, upgrading technology and containing costs. As part of this strategy, the company had reduced its headcount by a significant number. Management aims to lower its cost structure by a run rate of $300 million by the end of fiscal 2017.

During the quarter under review, adjusted EBITDA decreased 6.9% to $349 million, while adjusted EBITDA margin contracted 90 basis points to 9.4%.

Store Update

Whole Foods currently operates 455 stores in the U.S., Canada, and the U.K. The company opened 12 new outlets during the reported quarter, comprising the first “365 by Whole Foods Market” outlet in Silver Lake, CA. So far in the fourth quarter of fiscal 2016, the company has opened one 365 and two Whole Foods Market outlets, and plans to open one 365 and one Whole Foods Market outlets. Moreover, management believes that there exists room for 1,200 Whole Foods Market stores in the U.S. in the long run. It projects square footage growth of approximately 7% for fiscal 2016 and 6% for fiscal 2017.

Other Financial Details

Whole Foods ended the quarter with cash and cash equivalents of $472 million, total long-term debt and capital lease obligations of $1,052 million, and shareholders’ equity of $3,185 million.

During the quarter, Whole Foods generated cash flow from operations of $189 million and incurred capital expenditures of $183 million, resulting in free cash flow of $6 million.

The company paid $44 million in quarterly dividends and bought back $195 million worth of shares.

Guidance at a Glance

Whole Foods now projects sales growth of about 2% for fourth-quarter fiscal 2016, reflecting comps decline of 2.4%. Management now envisions earnings per share in the band of 23−24 cents for the quarter. The current Zacks Consensus Estimate for the quarter is pegged at 25 cents.