Deutsche Bank Asks: Is Whole Foods Worth Investing In?

In a report published Monday, Deutsche Bank analysts maintained a Hold rating on Whole Foods Market, Inc. WFM, with a price target of $54.

The analysts commented, "…our analysis reinforces our cautiousness on WFM because it shows the significant volume lifts or cost savings needed to fund price investments in order to maintain EBIT."

Against the backdrop of rising commoditization in natural/organic, especially in the non-perishable (NP) and frozen segments, the company would have to:

• Cut prices in NP, frozen and maybe even produce, which could expert downward pressure on margins permanently.
• Alter their offering in NP and frozen to be more unique. The analysts view this as a risk.

The analysts believe that prices are too high in some categories at Whole Foods Market. In view of the merchandise margin (MM) changes in 4Q14-1Q15, very little seems to have changed in price positioning.

"Comps were respectable in 1Q (in part due to the cycling of cannibalization and price investments), but the sustainability of WFM’s comps is at-risk if WFM cannot appeal to a broader price sensitive, customer base," the analysts said, while adding, "As natural/organic grows, and more formats offer similar SKUs, WFM’s success with mainstream consumers will ultimately depend more on price positioning."

"Margin risk #1: WFM following KR’s potential price investments in branded natural/organic items in the non-perishable and frozen categories." If Kroger Co KR reduces MM from the current ~33 percent to ~28 percent in branded NP and frozen, and Whole Foods Market follows suit, this would lower its MMs in the overall category by 180 bp, and would require a 24 percent lift in volumes even to breakeven.

"Margin risk #2: WFM becoming a national price leader in produce." In produce, Sprouts Farmers Market Inc SFM is the national price leader. Whole Foods Market would have to reduce MMs from 36 percent to about 25 percent. If WFM reduces prices only in overlapping markets, MMs would decline 320 bp, requiring a 70 percent volume lift to breakeven.