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Whole Foods Moves to Enact Faster Change

By Asit Sharma – May 11, 2017 at 4:00PM

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The natural and organic foods retailer introduced an accelerated plan to increase shareholder value, added a new CFO, and beefed up its board with new independent directors.

Whole Foods Market's (WFM) fiscal second-quarter 2017 earnings, reported after markets closed on Wednesday, generally fell in line its previously announced year-long outlook. Yet the report was overshadowed by a raft of announced changes meant to underscore the company's commitment to returning to solid revenue growth. Below, let's review both the numbers and the multipronged shift in strategy. 

No surprises in the quarter's results

Whole Food's comparable-store sales decreased 2.8%, a bit below the company's full-year expectation of a comps decrease of 2.5%. The comparable-sales decline was paced by a 3% drop in transactions, which was slightly offset by a 0.2% increase in average basket size.

Total revenue rose 1.1% to $3.7 billion, again within range of a full-year revenue expansion target of 1.5%. The company's gross margin decreased by just under 1 percentage point to 34% as it continued to make price investments to respond to competition from rival grocery chains. Whole Foods also incurred higher store closure and relocation expenses as it executed on its earlier decision to close nine stores during the quarter. Net income of $99 million represented a 30% retracement from the comparable prior-year quarter.

Night exterior shot of a Whole Foods store.

Whole Foods Market in Jacksonville, Florida. 

New strategic initiatives

At least two significant shareholders -- hedge fund Jana Partners and investment firm Neuberger Berman -- have recently voiced their displeasure with Whole Food's stagnant growth, and have urged management to explore strategic alternatives, including a possible sale to a competing chain.  

Undoubtedly in response to this pressure, management on Wednesday unveiled a set of five strategic initiatives which CEO John Mackey described as reflecting the company's "greater sense of urgency."

The first action is an accelerated rollout of the company's loyalty program, which has been in testing phase over the last two years within several metropolitan areas.

Whole Foods will now complete testing and expand the program nationwide in the current fiscal year, which ends in September. In other words, within roughly five months, all U.S. Whole Foods shoppers will be able to participate in the loyalty program.

The company is betting that the loyalty program launch will prove a major factor in helping lift its comps. On Whole Food's post-earnings conference call, management disclosed that a surprising amount of sales are running through the digital loyalty platform in test markets. Within flagship stores, 44% of sales transactions occur on the loyalty platform. In the smaller "365 By Whole Foods Market" concept stores, that number increases to 50%.

Whole Foods also intends to implement a companywide, unified purchasing program by the end of the current fiscal year. The company has traditionally allowed its eleven U.S. geographical regional offices a fair amount of autonomy in operational areas, which extends to commodity and packaged goods purchasing. But these practices will soon come to an end. By unifying its product purchasing, Whole Foods will be able to realize economies of scale that it hasn't previously. 

As discussed in the earnings preview, Whole Foods is also accelerating the pace of its category management initiative with the assistance of Dunnhumby. A subsidiary of British grocery chain Tesco, Dunnhumby uses proprietary software to help grocers improve their offerings based on customer data. Whole Foods' third initiative sets a goal of completing this category management program across all U.S. stores by the end of fiscal 2018.  

A fourth initiative builds on the success of the company's $300 million cost savings program, which will be completed at the end of the current fiscal year. Through 2020, the organization expects to achieve an additional $300 million in cost efficiencies, through automated labor management, standardization of in-store processes, and supply chain optimization.

Finally, Whole Foods introduced a series of new financial targets as a fifth initiative. Management now predicts a resumption of positive comps and earnings growth by 2018. And by 2020, Whole Foods seeks to achieve $18 billion in annual sales on the back of comps growth of 2% or more.

As for margins, Whole Foods plans to hold selling, general and administrative expenses to 27% of total revenue, and deliver an EBITDA margin of greater than 9.5%. For comparison, the company achieved an EBITDA margin of 7.7% during the current quarter.

Board and personnel changes

Are you keeping track of all of these changes? As part of its effort to convince stakeholders that the company understands how crucial it is to soon resume bona fide growth, management also announced the addition of five new independent directors to its board. 

You can view a full list with bios of each new board member in Whole Foods' investor presentation here, but two of the most notable choices are the appointments of Sharon McCollam, a former Best Buy CFO with well-regarded turnaround and retail expertise, and Ron Shaich, founder and CEO of Panera Bread. Both members should provide the company with sound operational and strategic guidance as it tries to refresh its image and its fortunes.

Whole Foods also introduced a C-suite change, announcing that Keith Manbeck, an executive with prior experience at Kohl's and Nike, will replace retiring CFO Glenda Flanagan. 

Looking forward

Shareholders are likely trying to make sense of the impact of the various initiatives and goals Whole Foods put forward alongside its earnings release. During the company's earnings call with analysts, Mackey made clear that the drive to raise comps would begin with its core customers. The company has determined that adding just one item per trip to a customer's basket via the loyalty program represents a half-billion-dollar annual sales opportunity.

But the initiatives also speak to Whole Foods' ongoing project to pull pricing in line with that of competitors'. Management intends to reinvest nearly all the projected $300 million of cost savings through 2020 into lower pricing, which should help drive traffic beyond the organization's core customer base. 

By introducing a new slate of seasoned independent directors, Whole Foods is also signaling its willingness to take advice in its quest to bump up sales growth and earnings. In sum, the executive team is pushing back against the narrative that Whole Foods needs to be acquired by another grocery chain in order for shareholder value to increase. But the extent to which investors exhibit patience with this alternative story line still depends on progress in comparable sales, and ultimately, top-line growth, in the coming quarters.

John Mackey, 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 Nike and Whole Foods Market. The Motley Fool owns shares of Panera Bread. The Motley Fool has a disclosure policy.

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