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Wal-Mart vs. Whole Foods

Whole Foods Market (WFMI) and Wal-Mart (WMT) both sell groceries. That's more or less where the similarities end.

In 2008, as the recession deepened, shares of high-end grocer Whole Foods plunged 77%, while discount retail giant Wal-Mart saw its stock jump 17%.

On May 14 the market responded to new quarterly earnings reports from the companies—reports that revealed a surprising similarity: Both companies are finding some success adjusting to tough times.

Wealthier Wal-Mart Shoppers

As a deep discounter, Wal-Mart has a natural advantage. "They're attracting new customers, and those customers are spending money," says John R. Lawrence, managing director of equity research at Morgan Keegan. A sign of the frugal times: Lawrence says the new customers tend to be wealthier than the typical Wal-Mart shopper.

By contrast, since the start of the downturn, Whole Foods has suffered from its reputation as an expensive place to shop for fancy food. Even as some worries about the economy have eased in recent months, that reputation is still hurting Whole Foods, says Morgan Stanley (MS) analyst Mark Wiltamuth. "Consumers continue to scale back on food purchases, [and] Whole Foods' price perception puts it at risk," he wrote on May 14. He added that his surveys find "even loyal customers consider Whole Foods to be too expensive."

Yet judging by investor reaction, Whole Foods is doing something right. On May 14, in response to the release of quarterly results, Wal-Mart's shares sunk 1.9%, to 49.10, while Whole Foods' rose 2.8%, to 20.55.

Whole Foods Beats Estimates

Wal-Mart had a "solid report," according to Lawrence. Earnings of 77¢ per share managed to nudge ahead of the 76¢ EPS Wal-Mart reported a year ago, despite the tough economy and even though the strong dollar hurt overseas sales figures.

Whole Foods reported earnings of 19¢ per share, vs. 29¢ a year ago, and sales of $1.9 billion were flat compared to a year ago. But the results beat Wall Street expectations. "Whole Foods provided further evidence that it plans to aggressively manage through the current U.S. recession and stabilize earnings," wrote Credit Suisse (CS) analyst Edward J. Kelly. (Credit Suisse provides investment banking services to Whole Foods.)

The grocer widened profit margins by cutting its costs. Also, by slicing new-store growth in half, Whole Foods managed to free up $98 million in cash flow—an important effort to reduce the company's debt load as it continues to digest its 2007 acquisition of Wild Oats Markets, a rival chain.

Customer Loyalty an Issue

Still, same-store sales (those of stores open at least a year) fell 4.8% last quarter. Because it consistently opens new stores, Whole Foods is used to big sales growth. Sales growth averaged 20.5% from 2004-08. Last quarter, however, total sales turned negative, falling 0.5%.

As the recession grinds on, Whole Foods must worry about whether it can hold on to its loyal but increasingly price-conscious customers. By contrast, Wal-Mart shares are down since the start of the year, and one reason may be concern about whether the chain can hold on to all of its new customers when the economy finally revives.

Wal-Mart President and Chief Executive Mike Duke specifically addressed the issue in a statement on May 14: "When economic conditions improve, we believe customers who shop at Wal-Mart today will stay with us because of the business improvements we're making and continue to make."

Leaving Behind "Whole Paycheck"

Morgan Keegan's Lawrence says Wal-Mart has improved store conditions that used to irk customers—for example, by managing inventory better and keeping stores cleaner. Plus, "people have experienced they can save money there," he says. Such savings can be "habit-forming."

At Whole Foods, executives are trying to convince customers that the chain's nickname shouldn't be "Whole Paycheck." "While it hasn't been an overnight shift, we believe we are starting to change the dialogue about our prices and hopefully the perception as well," Chairman and Chief Executive John Mackey told analysts.

Stores are putting more emphasis on sale items. "People are willing to buy provided they feel like they are getting really good value," said Co-President A.C. Gallo.

More Cost-Cutting Expected

The strategy is getting a few positive reviews. "Customers are responding to lower prices while service and experience are not suffering," said Canaccord Adams analyst Simeon Gutman in a May 14 note.

Whole Foods shares have more than doubled in 2009, as investors dismissed earlier fears about the future of the company. But, Gutman warned, future gains for the stock will need a real improvement in the economy. Investors are already expecting further cost-cutting. While improvements in Whole Foods' "price perception" could help, the company needs a strong revival in sales driven by an economic recovery.

It's a tale of two grocers, one high-end and one down-market. Whole Foods would probably benefit most from a strong economic recovery, while Wal-Mart holds a comparative advantage in tough times. But, with the economic situation highly uncertain, both companies—and their investors—are bracing themselves for either possibility.

Steverman is a reporter for BusinessWeek's Investing channel.

Steverman is a reporter for Bloomberg News in New York.

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