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Will Whole Foods Market Signal a Slower 2017?

By Asit Sharma – Updated Nov 1, 2016 at 1:44PM

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The natural and organic foods grocer reports on fiscal fourth-quarter 2016 earnings this Wednesday. Here's why shareholders shouldn't be surprised to hear conservative guidance going forward.

Image source: Whole Foods Market Instagram page.

Whole Foods Market (WFM) reports fiscal fourth-quarter 2016 earnings on Wednesday after the markets close. What should investors expect as the company embarks on its next fiscal year? For once, we don't have to strain our eyes squinting over murky tea leaves, as Co-CEO Walter Robb actually provided a succinct preview of possible guidance during last quarter's earnings conference call. Robb stated the following:

As we look toward 2017, we expect ending square footage growth of approximately 6%, down from 7% this year. Next quarter, we will provide more information on the expected number of Whole Foods and 365 openings along with other fiscal year targets. While we remain confident in our long-term growth potential, we plan to grow square footage at a more moderate pace this next year to lessen the negative impact of cannibalization on our existing stores and to allow us to focus more time and resources on our key initiatives. We are reviewing our entire development pipeline and, as appropriate, are making adjustments to capital budgets and operating models to reflect more conservative projections for comps and gross margins, as well as to apply the learnings from 365.

From the above, let's first treat a topic of great concern to analysts and investors: Whole Foods' comparable sales, or "comps," which have been declining for several quarters. Last quarter, comps fell 2.6%, which was actually a slight improvement over the 3% deterioration of the prior sequential quarter. Robb hints here that comps will remain soft for the near future.

A company can combat persistently weak or negative comps by ramping up store expansion. But as is clear in the quote above, Whole Foods is considering a further moderation of its store opening pace so that new stores don't cannibalize existing units as the company builds a denser footprint in metropolitan and suburban markets. Indeed, Whole Foods' overall revenue trend is also easing. Last quarter, total revenue increased just 1.9%.

Given that Robb stated last quarter that executives "have yet to see stability in [our] two-year comp trends," the first inference we can draw from lower comps and slower unit openings is that management intends to reveal slower revenue projections for 2017. Based on this year's performance, it's reasonable to guess that 2017 projections for top-line growth will fall somewhere between 0% and 3%. Unless the company has experienced a sudden spark during the fourth quarter, comps projections for next year are also likely to land in a range from zero to the mid-single digits.

The pressure on revenue isn't native to Whole Foods alone. Soft commodity pricing has created a deflationary environment for grocers over the last year. Deflation can crimp sales in this industry, as grocers tend to competitively follow each other in passing food cost savings onto customers, in the form of lower prices. So while margins may remain stable, the amount of sales a grocer records will decline, along with its pricing power.

Speaking of margins, Robb also mentions a more conservative outlook on gross margin above. Through three quarters of the current fiscal year, despite a more prevalent discounting program through its stores, Whole Foods' gross margin has declined less than 1% versus the prior year, to 34.5%. The company seems to be offsetting some of its price investments with solid margins on prepared foods and specialty items. Management has historically sought to protect Whole Foods' profits instead of yielding to the sirens' call of higher sales volume by way of widespread discounts and promotions. Thus, a "conservative" take on gross margin will likely mean that we see a projected 1 to 2 percentage point decline in 2017.

Why slower growth isn't necessarily negative 

If management does come out and forecast a slower growth environment in 2017, this may actually have decent implications for Whole Foods stock in the long run. Both organic and conventional grocery chains are working through a difficult stretch as they expand operations while battling each other for market share in a lukewarm economic environment. The growing presence of deep-pocketed European discount chains such as Aldi tends to complicate pricing strategies. And next year, German supermarket Lidl, which offers both discount and premium groceries on its shelves, will launch a full-scale debut in dozens of cities on the east coast. 

It may make sense then for Whole Foods to signal to shareholders that it expects a very moderate pace of growth for the next several quarters. This will allow management to focus on the right mix of 50,000-square-foot flagship stores, smaller neighborhood branded locations, and yet more diminutive, 30,000-square-foot "365 By Whole Foods Market" units, which the company is currently experimenting with.

Last year, it appeared that management's most pressing riddle was to figure out how to keep revenue from decelerating. Now, it seems more imperative for the company to understand how to comprehensively position itself in an increasingly crowded grocery landscape. A year of thoughtful investment in the future may help Whole Foods return to a faster growth cycle. Whether executives put forward such a blueprint or offer up more aggressive guidance on Wednesday, stay tuned, and we'll break it down post-earnings.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Asit Sharma has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Whole Foods Market. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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