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Author: rakapu One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3378  
Subject: Factoring the merger into expectations Date: 8/19/2007 1:15 PM
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Now that it seems much more likely that the merger will go through, I want to figure out how much that is likely to boost Whole Foods revenues going forward (in an effort to decide if WFMI stock is fairly priced or not).

First, we can start with historic data. Wild Oats does about $1.2B in annual revenue, as compared to Whole Foods $6.0B. So our first estimate can be that the merger will boost Whole Foods revenue by 20%.
This won't quite be the case, though. In his CEO blog, Mackey has stated that Whole Foods plans to sell off two of the farmer's markets store brands owned by Wild Oats, which together represent 30% of Wild Oats revenue. This would reduce the revenue contribution of the merger to about $840M, or 14% of Whole Foods revenue.

In that same blog, Mackey further states that Whole Foods plans to close some of the Wild Oats stores. While he doesn't specifically state how many stores, he does estimate that the total revenue increase from the merger will be about $700M, so we can deduce that about $140M in sales will be closed. It think it's probably fair to keep most of that $140M in revenue, though. From the un-redacted FTC filing, we know that Whole Foods estimates the closing of Wild Oats stores will ultimately increase revenues at related Whole Foods stores by 85-90%. While we can't be sure exactly how those numbers were arrived at, we can estimate that much of the closed Wild Oats business will go to Whole Foods stores. So I'll guess that the merger will boost Whole Foods sales by $800M total, or 13%.

There is a little more upside, though. Whole Foods believes they will be able to signficantly boost the sales of existing Wild Oats stores "through investments of additional financial and intellectual capital to remodel and improve the stores." Whole Foods sales per sq. ft. are roughly 100% higher than Wild Oats. If they can bring Wild Oats stores up to "Whole Foods" standards, that would boost the annual revenue value of the acquisition to $1.6B.

Of course, it will take time for the merger to take place, and also time to "WholeFoods-ize" the Wild Oats stores. If we assume the $1.6B in additional sales is realized over the next 5 years, that's an annual growth rate of 4%.

Where does that leave Whole Foods in terms of overall growth? Their comp sales growth is somewhere along the lines of 7%. New store openings planned in 2007 are 18-20, or roughly 10% of the existing 190+ stores. Combined with the Wild Oats acquisition, that would be an annual growth rate of about 21% over the next 5 years. Of course earnings growth might not track revenue growth, but I'll stick with the assumption that it will. That would be just on the high-end of Whole Foods expectation of 13-17% annual growth (excluing the Wild Oats acquisition), but below their 25% growth necessary to reach the goal of $12B in sales by 2010.

With $1.34 in trailing earnings and a current price of $44.30, Whole Foods PEG is 1.54. (I like to look at PEG for high growth companies, because my experience has been that the market generally pays for growth, and growth only, in high P/E stocks). This PEG is a little high, but not far off from another company that jumps to mind as a similar situation -- SBUX (PEG is about 1.4).

If Whole Foods is able to maintain the growth and command that same PEG over the next 5 years, that would mean that the stock price should appreciate at the same rate as the earnings growth, which I'm estimating would be a market beating 20%. If they can't continue to command that same premium, and the PEG were to slip to 1.0 over the same 5 years (perhaps if the market stopped believing they could grow at 20% per year or if future growth prospects dimmed), then the annual price appreciation would be a more mundane 11%.

Ron
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