Whole Foods' Big Markdown

Shares of the U.S. natural foods leader plunge after it posts a 31% profit drop, as economic troubles hit the organic grocery market

by Ricky McRoskey

Investors tossed aside Whole Foods' (WFMI) shares like they were wilted arugula on Aug. 6 after the company reported rotten third-quarter results. But some Wall Street pros think the sell-off was overdone.

On Aug. 6, the largest U.S. organic grocery chain saw shares fall nearly 20% in mid-day trading after it reported third-quarter profits of $33.9 million, a 31% decline from the previous year. The announcement held more bad news for investors: The company said it planned to reduce the number of new store openings by up to 50% and suspend its 20¢ quarterly dividend. It also reported that sales growth at stores open more than one year slowed to 2.6%, from 6.7%.

In Whole Foods' Aug. 6 conference call with analysts, the company's chief executive, John Mackey, said that the perfect storm of higher gas prices, a slowing economy, and higher food costs has scared consumers away from the upscale grocer and thinned the company's margins. Shares, off more than 60% from a 52-week high of 53.65, rebounded slightly at the end of the Aug. 6 session, to end the day down 12% at 20.04.

Amid Slowdown, High-Quality Image Hurts

For years, the Austin (Tex.)-based company has fed off the popularization of organic foods, seeking to cater to "customers aspiring to a healthier lifestyle" with organic vegetables, high-quality meats, and gourmet cheeses. The company, which runs 271 stores in the U.S., Canada, and Britain, booked $6.6 billion in 2007 revenue.

But as inflation and growing unemployment have taken a bite out of consumers' purchasing power, some are shunning the store's high-quality image in search of cheaper alternatives. After the temporary boost in May from government stimulus checks, inflation-adjusted disposable income for U.S. consumers dropped 2.6% in June. As a result, according to a recent 70-person survey from equity research firm ThinkPanmure, 19% of organic food shoppers said they were purchasing less natural and organic food than they did in the past, because of difficulities such as falling home prices, lower job security, and commodity inflation.

"I had thought that once you start buying natural organic, you don't go back," says Susanne Price, vice-president for research at ThinkPanmure. "But the fact that 19% were willing to shift backwards was surprising." Price says that a wider survey range would probably bring about an even greater percentage of those willing to trade down for groceries.

Analysts worry that the tepid 2.6% increase in comparable-store sales portends more weakness. During the first four weeks of the fourth quarter, same-store sales were up only 0.9%, and company management revised yearly sales estimates downward from a 30% increase to 23%. Furthermore, the number of store transactions—every time a customer makes a purchase—was flat in the third quarter. "It means people aren't shopping there more, and they're not buying more stuff," says Price. A recent note from UBS (UBS) indicated that the risk of owning Whole Foods stock outweighs the potential reward.