Thanks for Nothing, Wild Oats

By Alyce Lomax

The Motley Fool

November 6, 2008

Can someone pass an antacid? Or whatever its herbal equivalent might be? It seems like Whole Foods Market (Nasdaq: WFMI) has quite a case of indigestion from its acquisition of Wild Oats Market, and the tough economic times aren't helping it go down any easier.

A quarter for strong stomachs

Fourth-quarter net income at Whole Foods dropped 96% to $1.5 million, or $0.01 per share. (Note that the same quarter last year included an extra week.) That might make shareholders queasy, considering that adjusted total revenue actually increased by 13% to $1.8 billion. Comps rose by a mere 0.4%, compared to the healthy year-ago 8.2% increase.

A litany of charges hit profitability:

· $0.05 per share related to idle Wild Oats properties.

· $0.02 per share for 13 lease terminations of Whole Foods stores in development.

· $0.01 per share in asset impairments at two Wild Oats locations.

· $0.04 per share in tax charges related to taxes on the repatriation of $60 million in cash from the company's Canadian subsidiary, whatever the heck that means.

Relocation, store closure, and lease termination costs skyrocketed 482% to $27.2 million. Interest expense doubled to $8.3 million.

However, bear in mind that comparing the GAAP net income on a year-over-year basis is confusing and fairly meaningless. This quarter included all those unusual one-time charges, which magnified the profit drop. If you make an attempt to strip out the impact of the extra week in the quarter last year, and then back out the one-time, non-cash charges this quarter, the net income drop (by my estimated calculations down 42%) looks slightly less pronounced.

I don't know whether you've started hating Wild Oats yet, but if you haven't, I have a few more reasons. How about the $15 million to $20 million Whole Foods expects to spend in 2009 defending itself against the Federal Trade Commission's continued witch hunt? And then there's the impact Wild Oats made on Whole Foods' balance sheet, which leads us to ...

A different kind of green

Whole Foods got an infusion of capital from Green Equity Investors V, an affiliate of Leonard Green & Partners. LG&P has invested in such retail notables as Petco, Rite-Aid (NYSE: RAD), Neiman-Marcus, Sports Authority, and The Container Store.

Whole Foods will receive $425 million from the sale of preferred stock. That investment -- which will give Leonard Green a 17% stake in Whole Foods, if the shares convert to common stock -- will pay an 8% dividend. (In its defense, Whole Foods isn't exactly alone in getting a capital infusion. Look at Warren Buffett's similar deals with Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE) several months ago.)

Whole Foods plans to use the money to pay down its total debt of $929 million, much of which it took on to buy Wild Oats. In addition, the company has also drawn $195 million on its $350 million credit line. Although it paid down $32 million during the quarter, it plans to pay off the credit line in full when it gets LG&P's money. Whole Foods also mentioned that it's in compliance with all its debt covenants. (Well, phew.)

Debt can be a useful tool, but these days it's also more dangerous than ever. I'm glad to see Whole Foods trying to pay down some of that debt, and able to raise the capital to do so, given the credit markets' precarious situation. With many retailers in potential need of credit, and not much spare cash floating around for the taking, we may have to kiss some retailers goodbye.

Why, why, why?

The bad economy makes it tempting to wish that Whole Foods had never even imagined taking over Wild Oats. When the acquisition news first broke, I thought it would be no magic bullet; now it's starting to feel like a regular, non-magical, incredibly painful sort of bullet. The buyout has mucked up Whole Foods' balance sheet and spurred a dogged and bizarre antitrust crusade by the FTC, which seems to be ignoring the many mainstream retailers like Wal-Mart (NYSE: WMT), Safeway (NYSE: SWY), and Kroger (NYSE: KR) that have also muscled into the organic-goods business. If anything, the current hard times make the FTC's position look more ridiculous than ever. Then again, that position always seemed like it came from outer space, so I doubt the agency will back off now.

Given all my (regrettable) gloating when I'm right about a stock, I feel compelled to admit when I've made a bad call as well. I've been wrong about Whole Foods for a while now, and as a shareholder, I feel the pain, too.

That said …

I stand by my belief in this retailer's unique brand, its high-quality merchandise, its outstanding mission (treating employees and communities well), and its smart management. And gosh, if it was half price over the summer, it's even cheaper now, at about 13 times this year’s earnings. I mean, come on -- trading at a lower multiple than Wal-Mart, which has a P/E of 16? That's just nuts.

For all of Whole Foods' current digestive woes -- thanks ever so much, Wild Oats! -- future investors may regret not seeking out the company now, when it's down in the doldrums and cheaper than (organic, free-range) dirt.

Wal-Mart Stores is a Motley Fool Inside Value pick. Whole Foods Market is a Motley Fool Stock Advisor recommendation.

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

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