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Can Whole Foods Survive
Prolonged Economic Downturn?

Whole Foods Market will be reporting earnings for both its fourth fiscal quarter and its full year on Wednesday, November 5, 2008. The market is not expecting good news.

Whole Foods has seen its stock price decline 78% over the past year. The company had already eliminated its dividend and scaled back capital expenditures; now the word on the Street is that sales trends have gotten worse and that the company is expected to reduce its guidance.

David Kesmodel of The Wall Street Journal wrote a searing piece pointing out that the chain just has the wrong concept for the moment:

“They’re going to have to take their punches,” said Bob Summers, an analyst with Pali Research. “It’s kind of the wrong time, wrong concept.”

Kesmodel goes on to say:

Economic conditions since have worsened, making it even harder for the company, based in Austin, Texas, to attract customers to the gourmet foods that account for much of its profit, such as $15-a-pound sesame-crusted salmon and $9-a-pound mushroom-leek strudel.

Normally, an upscale concept in downscale times just has to batten the hatches and live to fight another day when the economy turns. But the article points to limits in the financial flexibility at Whole Foods:

The timing is particularly poor because Whole Foods aggressively expanded in recent years, often building stores that were bigger and more expensive than its earlier outlets.

One reason analysts expect Whole Foods to make further changes to its plans for new stores or capital expenditures is that it doesn’t have much wiggle room on its balance sheet. As of July 6, the company had about $25 million in cash and about $135 million available on credit lines.

The article implies Whole Foods is playing hardball to adjust lease terms:

Edward Aaron, an analyst with RBC Capital Markets, said he estimates the company has signed leases for about 70 new stores in the coming years. “The $64,000 question,” he says, is how much flexibility it has to back out of leases or revise terms.

One case in Seattle signals the grocer is willing to go to extreme lengths to rein in its growth. Seattle developer Interbay Urban Investors LLC in September sued the retailer, alleging that it reneged on a lease signed in 2005 to occupy a 60,000-square-foot store in a shopping center to be built in the city. Last July, with the center under construction, Whole Foods notified the developer that it preferred a 40,000-square-foot store because its sales projections no longer supported the larger format, according to the lawsuit filed in King County Superior Court. Whole Foods also wanted to delay the store’s opening by a year to late 2009.

In September, just a week before the developer was to turn over the store to the retailer to outfit, Whole Foods terminated the lease, according to the lawsuit. Many retailers are seeking to delay store openings or cancel them before leases are signed in the poor economy. But an anchor tenant walking away from a signed lease is a rare and troubling sign for retail landlords. The Seattle developer claims damages of nearly $68 million. The developer and his attorney didn’t return phone messages seeking comment Friday. Whole Foods declined to comment.

Last quarter Whole Foods announced it had lost $18.4 million in one year in its British operations. With other upscale retailers in the UK such as Waitrose and Marks & Spencer scrambling, it is hard to see the situation getting much better fast. Although Whole Foods CEO John Mackey had explained that the company had lost a lot of money in Canada when it launched there and that this was ultimately a profitable investment, with credit markets as they are and its share price as it is, the company may simply not have the financial flexibility to look to its long term plan.

Which raises five possibilities.

  1. Muddle through. By paring back capital expenditure and utilizing its credit lines, Whole Foods may make it through but if we are in for a long recession, there is a real risk that the company could eventually run out of money.

  2. Whole Foods may have to sell stock even at this stock price to raise capital and sustain its operational plans.

  3. Whole Foods may find a partner for its British operation that is willing to put in capital to sustain the operating loss and capital expenditures needed to grow the division.

  4. Whole Foods could shutter its UK division and staunch the bleeding

  5. Perhaps Whole Foods could sell itself to another retailer better able to carry it through the recession.

Which retailer would this be? Well it would be a logical play for any of the big three:

Tesco has had interest before but found it pricey. The new lower share price would give it an instant footprint across North America and allow it to roll its money-losing Fresh & Easy division into a new consolidated North American Tesco division. This would confuse the numbers and save Tesco from ever really accounting for the losses Fresh & Easy will accumulate.

Carrefour would value a North American division to diversify its revenue and profit sources. With the Whole Foods footprint and infrastructure, Carrefour could try to open many different formats.

Crazy as it sounds, it would also be a perfect fit for Wal-Mart. Very little customer overlap, different positioning in the mind of the consumer. There is a real risk of culture clash, but if Wal-Mart could convince Mackey to stay and run it as a separate division it would be a winner. Wal-Mart’s enemies would be thrown into fits of cognitive dissonance.

Whatever Whole Foods does, as we mentioned here, there is a real danger to its attempting to shake its image as high-priced. The core of the clientele at Whole Foods values shopping there because of a conviction that high prices enable Whole Foods to offer better quality, better food safety and to buy and operate more justly and more sustainably. If tomorrow Whole Foods lowered its prices to match Wal-Mart, it would alienate its core customers as they would assume that paying Wal-Mart prices means that Whole Foods bargained its suppliers down to what they presume to be Wal-Mart standards.

So the only choice is to stay in business long enough for the market to move its way. The question is how to do that.

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