Whole Foods' Cart of Risk

A few months ago, I dug into Crocs’ (Nasdaq: CROX  ) Form 10-Q filed with the Securities & Exchange Commission. In the process, I unearthed some things I thought it would be good for investors to at least be aware of, if not worried about. (It turns out Crocs completely wrecked.) In a similar vein, I decided to look through Whole Foods Market's (Nasdaq: WFMI  ) Form 10-K annual filing to get a handle on what has changed for the company, given its difficulties in the last year. There are certainly some elements that shareholders and people considering the stock right now should be fully aware of.

Picking through the risk
When looking at SEC filings, it can be very useful to look for what has changed year over year. Even though much of what you find in SEC filings is standard legalese, mining for new verbiage can be very enlightening. One of my favorite places to start is the “Risk Factors” section.

Comparing this year's 10-K versus last year's, Whole Foods has now added language about the risk of its "significant indebtedness." This is part of the reason I recently got frustrated about Whole Foods' acquisition of Wild Oats. The acquisition has had a very adverse impact on Whole Foods' balance sheet. Check out how interest expenses have burgeoned: In fiscal year 2008, interest expense was $36.4 million, while in the two previous years, it was $4.2 million and a mere $32,000, respectively.

There's also new language about possible impairment charges -- related to $659.6 million in goodwill and $1.9 billion in long-lived assets -- due to future economic factors.

Here's some disclosure that I'm sure is standard for companies these days: Capital may not be available for those that need it, although Whole Foods was recently able to obtain some from Leonard Green & Partners to the tune of $425 million.

In a total geek moment, I was fascinated by the rather stark language in the newly added section: "The capital markets are currently experiencing a period of dislocation and instability." Boy, I'm kind of missing the halcyon days when Whole Foods' risks were a little more run-of-the-mill and expected, like "Perishable Foods Product Losses Could Materially Impact Our Results." Sheesh.

A costly proceeding
Unfortunately, another downside to the Wild Oats acquisition has been the Federal Trade Commission's wacko witch hunt. Frankly, if the government can even consider saving competitively challenged companies like General Motors (NYSE: GM  ) and Ford (NYSE: F  ) -- not to mention the financial companies that got us into our economic mess -- I don't see why a government agency insists on pursuing an antitrust case against a company that has plenty of competition.

Trader Joe's, Wal-Mart (NYSE: WMT  ) , Kroger (NYSE: KR  ) , Safeway (NYSE: SWY  ) , smaller regional grocers, and independents are among Whole Foods' many competitors. (And of course, nobody's holding a gun to anybody's head and demanding they buy organic to begin with.)

At any rate, the situation with the FTC garnered a long section that I can't really give a quick synopsis of, although it did outline about 10 rather daunting ways the FTC could make Whole Foods’ life miserable if it prevails. In some pretty standard language for such situations, the company disclosed that the outcome could have a material adverse effect on its financial condition or results of operations (which, of course, goes without saying).

In addition, Whole Foods added some language about risks pertaining to acquisitions in general -- for example, saying that costs associated with integrating such operations may be greater than anticipated and may distract from day-to-day business more than expected, or that they may adversely effect business, results of operations, financial conditions, and cash flows.

Risk and reward
Much of the legalese in SEC filings -- especially risk factors -- simply offers full disclosure of events that are possible and may come to pass, and of course every company has risks. Meanwhile, most of what we can glean from Whole Foods' filing is information we were already aware of. However, I'm a firm believer that investors should keep their eyes wide open to all scenarios and pay close attention to these disclosures and how they evolve or change.

I can't deny that Whole Foods has become a much riskier investment than it was just a year ago. I have often said that in the current economic climate, investors should try to focus on strong companies that have a lot of cash and little debt. Unfortunately, Whole Foods is no longer that kind of dream investment. Of course, there is the argument that debt concerns -- the addition of risk, really -- have helped drive the stock down to dirt cheap levels.

Whole Foods, which is a Motley Fool Stock Advisor recommendation, is trading at just 13 times earnings, just for starters; this stock traditionally traded at nosebleed multiples, although the boom-boom economy helped it drum up the kind of growth that creates a premium stock price. Still, it's an innovative company with plenty of room for growth, so I'd argue hope is not lost for patient investors.

I also feel Whole Foods is a well-managed company and certainly not a fad. I still fully believe in the competitive advantage in its mission, too, including its stellar treatment of employees, the quality of its merchandise, and its innovative initiatives into areas like micro-finance, environmental consciousness, and animal welfare.

I'm holding on to Whole Foods; it has traditionally been one of the stocks that I have always intended to hold for years, maybe even decades, and I respect its business. However, to be forewarned is to be forearmed -- and accountable. I think shareholders should always take it into account when a stock has become a whole lot riskier.

Whole Foods Market is a Motley Fool Stock Advisor recommendation. Wal-Mart Stores is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days.

Alyce Lomax owns shares of Whole Foods Market. The Fool has a disclosure policy.


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  • Report this Comment On December 20, 2008, at 9:40 AM, wax wrote:

    So I looked through a bunch of junk I have on this stock and found out that I have never been enamored. Wow, there's a shocker, Wax not a fan of a Foolish stock selection? Say it ain't so!

    At any rate, I checked and found that I have the stock on my watch list with a reasonable value estimate of $31, based on the company’s fiscal 2008 10-K numbers. My watch list also showed a buy target of $15.50 and Whole Foods with a recent close of $9.96 is certainly below $15.50.

    So how come I’m not buying? The answer is because price is only one part of my investment considerations and in looking at my worksheet for the company’s current annual financial statements, I understood why I wasn’t a fan of the company.

    Like many investors, in addition to price, I have other metrics that I use when researching a stock. Unlike most investors, it’s all of the other metrics that serve to support my reasonable value estimate.

    The first thing that jumps out at me about Whole Foods is Goodwill and Intangibles to Total Assets of almost 22%. That tells me that almost a quarter of the company’s total assets are made up of smoke and mirrors.

    Additionally, the company’s free cash flow margin, which I like to see above 10%, is at woeful 0.58%.

    Couple that little bit of information with the company’s $0.22 per share of cash and it’s $6.62 per share if debt, and there is no way that the financials support my reasonable value estimate.

    So if you own this one, it may be a good time to sell. Then in a few years when the company’s penultimate egotist and CEO has hopefully been shown the door, perhaps you can get back into the stock.

    At least at that point, investors will have learned the difference between farmers’ boots and cowboy boots.

    Wax

  • Report this Comment On December 26, 2008, at 7:53 PM, Chickenpookie wrote:

    Thanks Wax, I enjoyed your take on this subject and actually learned a few things.

  • Report this Comment On December 26, 2008, at 8:41 PM, louisryoshin wrote:

    Whole Foods is a greedy stupid company. For the very reason you sited causing it all that debt. while its Whole Foods stores before the merger were pretty good health food supermarkets and situated in wealthy areas so that people could affor their relatively high proces for the same kinds of products, it caused a lot of harm to itself and to society as a whole, by destroying a lot of the ehalth food advantages available in Wild Oats stores.

    They chose to close a relatively small but 6-7 years profitable Wild Oats store that was the largest health food store in hundreds of miles - in many directions, and had a continuous and loyal customer base because it provided a very much needed resource for tens of thousands of people on the Florida Space coast - Ft Pierce, Vero Beach, Sebastian, Melbourne-Cocoa, and surround areas. A fairly wealthy area in itself with a very stable aerospace, air force and health oriented retiree population and even an increasing population.

    First they killed the frresh juice bar which was a tremendous draw for people from miles around, and we would shop and buy from their deli that was definitely better than Whole Foods' and also get a great salad bar that Whole Foods then killed and also they killed the incredible Wild Oatts Deli. In fact, this store was responsible for causing at least two smaller stores in the area to stop selling produce and then stop their deli bars and juice bars. It was THE place people from the business rea would come for healthy food, including the largest hospital in hundreds of miles as well. then they complained it did not bring in $1million per month and layed off dozens fo healthy oriented people and knocked down the health orientation and health food community for the entire area.

    At the same time they built a very expensive store in a rich area of Orlando and had the idiotic nerve to place signs on the doors inviting the local populace to drive 1-1/2 to 2 hrs to their New Orlando Store. And in the midst of all thei they aquired even more dept for the building and of the purchasing of the Wild Oats Store And they closed a well established profit center that would till have an ongoing economically secure customer base. Wild Oata was even a small cafe that attracted health practitioner speakers on a weekly schedule and many of us used it as THE health networking location from Vero Beach to Vierra, both wealthy health-oriented areas and wealth in between as well.

    In the Los Angeles Area they bought out the two Santa Monica (read: you have to be a millionaire to own property here) - and they eventually closed the juice bars there - these two stores were in very upscale areas and also had juice bars that were often continuously popular with lines, and a large deli in each - and like the store in West Melbourne, Florida, was a place shoppers would come for the juice bar or salad bar or a deli sandich or plate for lunch especially or after chirch or often in the early evening - and then we would buy our food to bring home.

    In these areas evenin Santa Monica, people who worked there knew the people who shopped there - and it promoted daily purchases. Just in juice purchase i would spend $15-$25 a day, 5-7 days a week, month after month. When I was at the store in Florida, I would often see a wealth psychotherapist I knew whose husband owned an apartment complex for health oriented people - she would drive the 35 minutes in just to get some juice.

    the amount of anger and sadness directed at the Whole Foods orhganization created by the closings of the health aspects of all these stores just adds negativity to their overall balance sheet. the 4 year old son of my American Chinese Medicine Doctor, in Florida (who works in an MDs office and also teaches in his field) said, "Dad, where are we going to shop, now that Wild Oats is closed?"

    How can this be a good business practice? I believe in investing in oil companies as well as solar energy companies, and while I am ordained religious Monk of a huge legitimate religiion with weeklong intensive meditation retreats monthy. I'm not a goody goody air head. But I do know good business sense and community inter-relationships so that you build up customer layalty for generations and spread the word in an ever increasing upper middle class 200 mile long section of the florida Coast and in the must desirable health oriented cosmopiolitan area of the Los Angeles basin. I built up organization memberships and built my own business that would get seven levles of referral and I was only one guy.

    The Wild Oats in Melbourne receive community awards.

    And in my mind as an aerospace and communications engineer, and both a body and psychology therapist, I think the company is not dedicated to health, as a good small business founded and run by people dedicated to the kind of organization but rather is a marketing system that hired good health food knowledgeable people to stock their stores.

    But management's understanding of PEOPLE'S health is missing and therefore they have accumulated the debt that you say is not good on their balance sheet. It would be like Intel trying to buy out AMD and other chip makers to try to corner the market and taking on huge dept in order to do it. that is what Whole Foods did and now, their shareholders lose, their former employees lose, and their customers lose. therefore the United States of Amercia loses.

    As a monopoly and huge company they can bring in money but as you say they did it by saddling themselves with an issue that even Motley Fool dies not approve of.

  • Report this Comment On December 26, 2008, at 8:57 PM, louisryoshin wrote:

    PS -

    1. I agree wirth Wax and I am glad to see another investor saavy about the top management.

    2. in the book, A Roadmap of Time by Brad Steiger (Amazon,com) and his companian book Brad Steiger Predicts the Future (Amazon.com) he discusses the 100 and 500 year weather and economic-socilogical cycles of the world going bad a couple thousands of years, descibing the discoveries and charts of Wheeler and Maxwell in the first half of the 20th Century. We are currently in a consolidation phase at the beginning of a new 100 and 500 year cycle - and that includes the beginning of an economic power shift to Asia from Europe and the US.- and this info was first discovered almost 100 years ago based on detailed long term research of worldly trends and Steiger's books were published in the 1970s. However, as companies consolidate, the good also emerges from the bad and new, better companies will come out of where we are now. It is too bad that we are just at the end of the last 100 year and 500 year cycle with such rampant corruption and as Wex says, paper profits, as an elliot wave fifth wave has. And we have just finished the fifth wave of the grand supercuycle, the fifth of the supercycle and the fifth of the cycle.

  • Report this Comment On December 26, 2008, at 9:55 PM, louisryoshin wrote:

    PPS - to Motley Fool, from a long time Shopper's experience, Whole Foods is not exactly in competition with WalMart and other Supermarket stores.

    Only if I go into Whole Foods for green juices and an organic salad bar, would I then buy almonds, or pineapple (as sold in WalMart). And I would prefer to buy paper towels, bottled water and toilet tissue in WalMart because it is so much less expensive for these and many other products. And one cannot buy organically grown collards, kale, endive, chard, parsley, spinach, carrots, beets with greens, grapes, strawberries, pineapple, and peaps in pods at Walmart and only in a few Publix supermarkets here.

    Further, the Whole Foods prices put them in another category from other stores that sell similar items. And in fact, they do NOT sell similar items. Supermarkets sell water supply polluting paper towel etc products, They sell chemical laden animal products. They do not sell seaweed in large bags. They do not sell organic sesame tahini. And they do not sell organic oranges, almonds, sesame and sunflower and pumpkin seeds, and so forth. And they do not sell bulk whole grains organically grown.

    I might buy a used bycycle in a bike store but I'd go to a new car dealerchip for one of those cars and a cadillac store or a used car lot with old hondas for other kinds of cars. Yet it is all transportation.

    In our Florida area there is only one, much smaller health food store that does freah juices, but has no salad bar and limited days of produce, and people who live in upscale areas who buy a huge chopping basket of products each week, told the Wild Oats W,F. Marketing Manager that store could not support their purchases.

    Nor can another health food store with a tiny and much more expensive produce area. the only other store in the near area is a Food Coop about 30 miles north.

    In Santa Monica, however, the Wild Oats Stores and the West Los Angeles and Brentwood Whole Foods Stores did indeed sell the same kinds of products as each other and as smaller health food stores with produce sections, in the area, including the Santa Monica Food Coop..they were very much similar stores and the clientelle who frequented one company would often go to the store of the other company,and not as much to the large supermarkets in the area. When I lived in Venice area of Los Angeles last year, I shopped at the Wild Oats stores, the Santa Monica Food Coop and a medium size health food store in Culver City - somewhat south, and sometimes in another medium size one a little toward the ocean, They were all identical like stores except for the size. And occaisionally I went to Ralph's Supermarket down the street for bottled water and some organic strawberries. But more often I got jugs of the water from the Food Coop where shopped 10 times for every Ralphs.

    So the competition is not what the report from the Whole Foods says. People either like the health food store food or the supermarket food, and now, more people here in Florida's Space coast are feeding their cjildren more foods with pesticides on them.

    So the monoply Merger did take place and closed stores and features of stores that the other chain could afford to do and then make a profit from getting more and consistent shoppers in the store.

    It's all Whole Foods for health foods on the West Los Angeles, Brentwood, Santa Monica area, and Whole Foods has opened up a large store in Venice, threatening the other health food stores I mentioned. they will not threaten the Ralphs or Vons supermarkets nor the WalMart superstores all over the Florida Space Coast every few miles, with their deep frined Okra versus the organic salad bar.

    I noticed that after the juice bar was closed and the salad bar and Deli were significantly minimized, the West Melbourne store felt "flat" or lower energy. And this lack of aliveness was not the case in the huge Wilshire Dlvd West LA store nor the previous Wild Oats ownership store in West Melbourne - in fact, in the local Wild Oats, people stayed there to work versus accept a job that might have paid more elsewhere because they liked the energy in the 'store. I alwasy noticed it too. I'd come out of there feeling a lot more energized than when i went in, nomatter how I felt when I went in.

    Publix down here in Florida has picked up some of the slack of the lack of Organic produce, especially in the Beachside - the most upper scale of the entire space coast, by far. But it is considerably more expensive and with much less selection than the Wild Oats was and the smaller health food store was. They also sell bottled, flash pasturized (read: cooked) carrot juice and at Wild Oats we could get it fresh and network professionally, socialize personally, and learn healthwise. And there is no place there to have healthy food.

    In Publix's deli people come for pastami sandwiches on white brad and fried chicken. In Wild Oat's there was a large selection of organically grown meats and fish-poultry, a large amount of vegetarian and vegan dishes, and an entirely different kind of populace. In Walmart's eating section there are McDonalds and a fried potato and greasy chicken stand.

    These are not competing kinds of stores even though they both sell food. If you are reading that from the Whole Foods argument, then as someone "on the ground" and involved with the purchasing habits of the people in the areas, I can say the reality and what you read do not say the same things in my experience.

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