Whole Foods' Big Markdown

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Wall Street Warms to "Management Capitulation"

But the company's third-quarter announcements might actually be a good sign, says Scott Van Winkle, managing director of equity research at Canaccord Adams. Whole Foods acknowledged it needs to tone down some of its overly aggressive growth strategies, says Van Winkle, who adds that the upscale grocer's new stores in Britain have been "hemorrhaging money" over the last 12 months, with $18.4 million in losses. Also, Whole Foods emphasized its efforts to shed the quasi-luxurious image by placing "value gurus" in its stores—employees who direct customers to various food discounts and savings opportunities.

In the conference call, CEO Mackey said Whole Foods plans to cut all discretionary capital expenditures that aren't related to new stores by 50%, and is also "actively working to drive down the average development cost per square foot" in its stores. Those moves could signal a turnaround mentality and a push for greater efficiency, say analysts. "I think there was much better communication with Wall Street and much better recognition about weakness in the environment," says Van Winkle. "Oftentimes I tell our clients to buy stocks when there's a market capitulation. In this case there's a management capitulation, and I think it's definitely a positive."

Wrote Mark Miller, a research analyst at William Blair & Co., in an Aug. 6 research note: "The weaker current trends are causing management to pull back on capital spending today, which does set the stage for improving returns in the business when the economy improves."

Natural Food Companies in Danger?

The other question for investors is whether the natural food industry is in jeopardy as a whole. To that end, most analysts agree that companies like Whole Foods are seeing short-term weakness stemming from lackluster consumer confidence, but the long-term industry outlook is healthy. "We believe the market niche for high-quality natural and organic food will expand over time," says William Blair's Miller.

While Whole Foods should benefit from strong long-term demand, those best positioned right now are independent organic food companies like Hain Celestial Group (HAIN) and United Natural Foods (UNFI), according to a research note from Citigroup's (C) Gregory Badishkanian. Consumers have been trading down from restaurants to grocery, but they've also traded down among grocery stores—which hurts a "higher price-perceived retailer" like Whole Foods, he says.

Investors shouldn't be concerned about the store's concept or the organic marketplace, but rather how Whole Foods may be shifting from a growth stock to a value stock, says Van Winkle. "The story is it's really the best in-class operator becoming a little more of a staple than a growth story," he says.

And if Whole Foods is indeed a value stock, it's a whale of a lot cheaper now.

(Note: Citigroup does investment banking for Whole Foods and Hain, and owns or controls 1% or more of Whole Foods stock. William Blair & Co. owns 1% or more of Whole Foods stock. ThinkPanmure makes a market in Whole Foods securities. UBS makes a market in Whole Foods securities and one of the report's writers, project members, or one of their household members holds a long position in Whole Foods stock. Canaccord has Whole Foods as a non-investment bank securities-related client.)

McRoskey is an intern at BusinessWeek.com.