Whole Foods Market, Inc. financial and strategic analysis

1. June 1, 2011
Whole Foods Market, Inc.
Intrinsic value lower than market
price; Likely to face increased
competition in the near future;
Concerns about the growth strategy
and some red flags on accounting
practices.
Investment conclusion: despite we forecast
sales growth and an upward trend of EPS, we
raise our concern about the over-valuation of
WFM, which currently trades at 35.21x P/E,
against the 19.98x P/E of its industry. We believe
WFM growth strategy mainly based on new store
openings and acquisitions is not sustainable
because costly and margin-shrinking, thus we
forecast that in the best case scenario ROE and
RNOA will be flattering in the upcoming years.
Given also the high 12.96x ttm EV/EBITDA
(comparable Safeway has 5.60x ttm EV/EBITDA),
and the extraordinary upward trend started in
November 2008 (+647%), we expect a realignment
of the stock to the industry P/E multiple levels and
we believe (softening the valuation of $28.55 given
by eVal) the WFM could fall to $40 by the end of
the fiscal year. As a result, our rating for WFM
stock is UNDERWEIGHT.
Company Description: Whole Foods Market, Inc.
engages in the ownership and operation of natural
and organic foods supermarkets. It offers
produce, seafood, grocery, meat and poultry,
bakery, prepared foods and catering, specialty
(beer, wine, and cheese), whole body (nutritional
supplements, vitamins, body care, and educational
products), floral, pet products, and household
products. The company operates over 250 stores
in the US, Canada and the UK.
Retail, Food and Drug/United States of America
Industry View: Attractive
Stock rating:
UNDERWEIGHT
Industry Rating:
ATTRACTIVE
Alessandro Masi
AMasi2011@hult.edu
+1 415-717-9448
Daniele Foti
DFoti2011@hult.edu
+1 415-827-7247
Key Ratios and Statistics
_______________________________________
NasdaqGS: WFM
Industry: MG734 Retail Stores – Grocery Stores
Price Target $40
Shr price (May 31, 2011)**
Shrs outstanding (mm)*
Float (%)*
$61.16
175.131
89.09
Mkt cap, curr (bln)*
Dividend Yield (%)**
$10.44
.67
52-Week Range**
Beta**
$33.96-$66.87
1.15
* Source: Bloomberg
** Source: Yahoo! Finance
Fiscal Year Ending 09/10* 09/11e** 09/12e** 09/13e**
EPS($) 1.48 2.00 2.18 2.36
Consensus EPS ($) NA 1.90 2.13 2.45
RNOA (%) 9.4 9.8 9.7 9.6
ROE (%) 12.0 11.1 10.6 10.3
* Source: Yahoo! Finance
** Source: eVal

2. 2
Industry analysis: overall, the industry follows an
upward trend; therefore a general growth in sales
can be forecasted for the Company in the next
quarter, especially given the movement towards
the specialty food sector, which grows faster than
its comparables.
Source: www.bea.gov
Moreover, the trend followed by the personal
consumption expenditures for food and beverages
purchased for off-premises is increasing steadily
since 2006 (despite the temporary bad
performance in 2008) and is forecasted to keep
growing.
Source: www.bea.gov
All in all, this makes the industry attractive, even
though particularly sensible to disposable income
and GDP fluctuations.
Firm-specific analysis: among the various factors
that can affect the profitability of the Company, we
strongly believe that the following are going to
determine Whole Foods’ future earnings:
• the ability to open new stores, both in existing
trade areas and in new areas, including
international locations;
• customer satisfaction and the creation of value
for all its major stakeholders;
• the ability to involve all employees and create a
“Company-wide consciousness of shared fate
by uniting the interests of team members as
closely as possible with those of our
shareholders”;
• the capability to maintain profitable win-win
business relations with its suppliers in order to
keep the cost of the goods supplied low and to
maximize the margin;
• the global attitude towards organic and higher-
quality products.
Stores activities 2010 2009 2008 2007 2006
Stores at beginning of FY 284 275 276 186 175
Stores opened 16 15 20 21 13
Acquired stores 2 - - 109 1
Divested stores (2) - - (35) -
Relocated stores - (5) (7) (5) (2)
Closed Stores (1) (1) (14) - (1)
Stores at end of fiscal year 299 284 275 276 186
Year-over-year growth 6% 7% 6% 46% 10%
Sales identical stores 93.2% 91.4% 80.9% 88.8% 90.4%
Sales new/relocated stores 6% 7.8% 9.9% 8.4% 8.8%
Sales acquired stores 0.1% 0.0% 8.7% 1.3% 0.1%
Other sales 0.7% 0.8% 0.5% 1.5% 0.7%
Source: company filings
Red flags on accounting practices: some
concerns can be raised about high operating
leases and relatively low capital leases, no
impairment provided for goodwill in the Balance
Sheet, and the expended employment stock
options. Further, pre-opening expenses should be
considered as a non-recurring item.
Financial highlights: both ROE and RNOA are
higher than 14% in 2006, then drop dramatically
by, respectively, 7 and 5 points within 2 years,
then recover steadily particularly from 2009 to
2010, reaching acceptable figures; the sales from
the new stores are counterbalancing the decrease
in sales of the existing ones principally given by
the bad macroeconomic conditions. The total asset
turnover shows a downward trend, therefore the
business is moving from a cost leadership towards
a product differentiation strategy.
2006 2007 2008 2009 2010
Net Profit Margin 3.60% 2.80% 1.40% 1.50% 2.70%
x Total Asset Turnover 2.745 2.508 2.413 2.242 2.318
x Total Leverage 1.455 1.836 2.224 2.286 1.942
= ROE 14.38% 12.80% 7.70% 7.60% 12.00%
n. of stores 186 276 275 284 299
ROE (per store) 0.077% 0.046% 0.028% 0.027% 0.040%
Net Operating Margin 3.64% 2.81% 1.69% 2.10% 2.95%
x Net Operating Asset Turnover 3.969 3.629 3.417 3.080 3.181
= RNOA 14.43% 10.20% 5.79% 6.46% 9.38%
n. of stores 186 276 275 284 299
RNOA (per store) 0.08% 0.04% 0.02% 0.02% 0.03%
Net Borrowing Cost (NBC) 0.22% 0.66% 2.39% 4.77% 3.04%
Spread (RNOA - NBC) 14.21% 9.54% 3.40% 1.69% 6.35%
Financial Leverage (LEV) 0.62% 26.88% 57.00% 66.42% 41.51%
ROE = RNOA + LEV*Spread 14.52% 12.77% 7.73% 7.58% 12.01%
Source: company filings and calculations
The net borrowing cost is increasing within the 5
years period and so is the financial leverage, thus
the risk of the returns to equity holders is
increasing; the spread between RNOA and NBC is

3. 3
decreasing towards 2009 but recovers in 2010,
thus the ROE exceeds the RNOA in each of the
years to a larger extent since also the leverage is
increasing.
Source: company filings and calculations
Whole Foods needs to push its operating margin
up (therefore move towards product differentiation
and quality) in order to obtain a high RNOA and
generate value for its shareholders without
exposing the business to risk from high leverage.
Sales and PP&E forecasting: we believe a 5 year
time horizon is appropriate, given the
characteristics of the retail industry, where firms
are not involved in any long R&D process.
On top of the planned growth policy, we assume:
• 3 stores openings per year starting from 2015;
• 1% weighted average square footage growth
rate 1% starting from 2015;
• sales growth driven by footage expansion (with
a 50% estimated expansion productivity
adjustment) and comparable-store sales
growth, whose sum gives back the total growth
rate.
We believe a good estimate of the gross PP&E to
sales ratio for 2011 is the average of the ratios for
the previous three years. For the subsequent
years we estimated it as the moving average of the
three previous years. With the same process we
estimated the depreciation to PP&E ratio.
Finally, we also assumed that, given the
forecasted growth and the availability of earnings,
the Company may bring the dividend payout ratio
up by 0.5% yearly to 4% in 2016.
Source: eVal
The ratio analysis for the forecasted period shows
that both ROE and RONA are acceptable, being
close to 10%, the Profit Margin should be
improved, while the business should strategically
move from relying on assets towards product
differentiation. The advanced DuPont model
reveals the necessity to increase RNOA through
improving margins: leverage has been decreased
in the forecasted period, and this makes the
business less risky and hence more attractive for
investors. Margins have to be improved through a
more careful cost policy: however, we assumed
that due to the change of strategy, it would not

4. 4
have been possible for the Company to cut costs
in the 5-year period. The turnover ratios look good,
even though the net working capital turnover is
decreasing, but this is due to the change of
strategy. The firm is decreasing its leverage, hence
lowering its debt to equity ratio. Interest coverage
is improving steadily, and this makes the Company
more attractive for investors. The credit risk is
lowering.
Valuation parameters: we estimated a required
rate of return on equity of 8.92% calculated with
the CAPM, given a risk-free rate of return of
3.17%, a beta of 1.15, and a market risk premium
of 5%. Given the market capitalization, we did not
apply any size premium to the CAPM.
Given the market value of equity and debt, the
Company has the following capital structure:
(millions of $)
Equity 11,052.35 98.15%
Long-term debt 207.74 1.84%
Short-term debt 0.44 0.01%
Pref. equity 0.00 0.00%
Total 11,260.52 100%
Source: Bloomberg
Looking at the Company bonds, we estimated a
cost of debt of 3.36%.
Equity Debt
Weight 98.15% 1.84%
Cost 8.92% 4.36%*
W x C 8.75% 0.08%
*Source: we increased the actual cost of debt given by Bloomberg by
1% since eVal estimated it as internally-inconsistent.
Therefore, WFM has a 8.83% WACC.
Differently, eVal considers the firm’s common
equity, debt and preferred stock and then searches
the WACC that discounts the forecasted future free
cash flows to all investors back to this
predetermined amount: both approaches are valid
and particularly in this case since the WACC is
very close to the cost of equity, given the capital
structure of the Company.
The cost of preferred stock is 6.85%, estimated
from the dividend paid in 2009 and 2010 for the
425,000 outstanding shares of the Series A
Preferred Stock (approximate value $413.1
million).
There is no dilution factor for splits or stock
dividends, but an adjustment is needed for 18,946
options outstanding as of 2010 exercisable at a
weighted average price of $46.00, with weighted
average remaining contractual life of 2.99 years,
for a value of contingent claim per share of $25.53,
resulting in $483.70 million total value of
contingent claim.
Absolute valuation: the DCF valuation model
gives negative FCFE and FCFF for the first three
and two forecasted periods respectively because
of CapEx expenditures and the Wild Oats
acquisition in 2008 that penalize the valuation of
the firm. This pitfall is avoided by the Residual
Income model, where the value is recognized
earlier. The two valuation models suggest that the
intrinsic value of the firm ($28.55/share) is lower
than the current market price ($61.16/share).
Therefore, we believe the stock is over-priced,
even though the market probably absorbs such
premium given the growth potential of the
Company and the attractiveness of the industry,
and seen the extraordinary continuous upward
trend started in November 2008 (+647%).
We agree that the Company is shareholders value
and generating abnormal returns, but not to the
extent recognized by the market.
Overall, our recommendation is to sell the stock,
since the income generated might be due mainly
by accruals. We recognize cyclicality in the path
followed by the stock price that will bring it down
soon, and we also raise concerns about the growth
strategy and the risks of the business.
Sensitivity Analysis: given the price determined
by eVal, which uses a linear smoothing algorithm,
we consider $33.80 as the Base Case.
Bull Case: with an increase in sales growth up to
11%, an increase in terminal year’s sales growth
up to 5% and an increase of terminal year’s ROE
by 1%. Under these assumptions, we obtain a
stock price of $43.42.
Bear Case: with a decrease in sales growth down
to 7%, a decrease in terminal year’s sales growth
down to 3% and a decrease of terminal year’s
ROE by 1%. Under these assumptions, we obtain
a stock price of $27.86.
Such values say that the stock is particularly
sensible to slight increase/decrease of sales and
profitability.
Forecasting EPS: forecast EPS and consensus
analyst forecast of EPS both show an upward
trend and do not show significant differences, even

5. 5
though the latter has a wider range of variation
than the former within the period 2011-2013.
2011e 2012e 2013e
Forecast EPS $2.00 $2.18 $2.36
Consensus Analyst Forecast of
EPS*
$1.90 $2.13 $2.45
*Source: MSN Money
Market-based valuation: we believe that
Safeway, Inc. (NYSE: SWY) represents an
appropriate comparable for Whole Foods Market,
Inc. The two companies have comparable risks
and growth models. These characteristics make
the use of the P/E Multiple method acceptable.
Nevertheless, the capital structure and the way the
two companies depreciate their fixed assets are
different and have to be taken into consideration.
WFM vs. SWY
Item WFM SWY
Interest rate Swaps Swaps
Foreign
Currencies
Adjustments Adjustments
Commodity
Prices
Price contracts Price
contracts
Current
Economic
Condition
Sensitive Sensitive
Total
Debt/Equity
(mrq)
Most Equity Most Debt
Merchandise
Inventories
Valued LIFO,
remaining
FIFO
Valued LIFO,
remaining
FIFO
Property and
Depreciation
At cost,
building 20-30
years,
equipment 3-
15 years
At cost,
building 7-40
years,
equipment 3-
15 years
Growth Model New stores New stores,
CAPEX
Source: company filings
The following table represents Whole Foods’ stock
value calculated as a multiple of Safeway’s P/E,
currently trading at a discount to the market. The
figure shows that even with this method the
intrinsic value of the stock is by far lower than its
current price. To be noticed that this valuation
would be even more evident choosing other
comparables, such as Kroger (NYSE: KR) or even
Wal-Mart (NYSE: WMT), whose P/E ratios are,
respectively, 14.26x and 12.06x.
WFM Market-based Valuation (SWY)
Year P/E SWY 2010 EPS WFM
2011e
Price WFM
2011e 17.87 2.00 35.74
Source: Yahoo! Finance
The calculation of Whole Foods’ relative P/E ratio,
compared with S&P500 P/E reveals that in 2010
the stock was still trading at a premium, but was
converging to the market in 2010. Looking at
consensus EPS forecasts, relative P/E is expected
to rise again, confirming that the stock is still
trading at a premium to the market. Nevertheless,
we believe that this premium will shrink soon.
WFM Relative P/E Ratio
Year P/E (ttm) WFM P/E (ttm) S&P
500
Relative P/E
2006 42.15 27.20 1.55
2007 37.95 24.01 1.58
2008 24.42 15.17 1.61
2009 35.87 20.52 1.75
2010
2011e
25.95
35.21
22.97
23.66
1.13
1.49
Source: Yahoo! Finance

6. 6
Appendix: Whole Foods Market, Inc. financial statements from the 10-k 2010

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