Whole Foods Market Inc.’s Finance and Capital

Introduction

The primary objective of the current analysis is to select a company whose stocks are listed on one of the principal international exchanges. For this purpose, the New York Stock Exchange has been selected, and the company chosen is Whole Foods Market, Inc. The reason for selecting this company is the decline in the company’s stock price in recent weeks.

The decline in its stock value was due to the fall in the company’s last quarterly earnings. The company reported quarterly earnings of $95 million compared to $150 million reported in the first quarter last year. It could be a major concern for different users of financial information reported by the company. Moreover, the company is facing major business and financial risks, which are discussed in this report. The report includes findings of the financial ratio analysis using the PERL framework. Moreover, it provides an assessment of the firm’s cost of capital along with the discussion of its capital structure.

User Identification

The primary user group of the financial information prepared and published by the company is investors. Investors are primary stakeholders as they provide the required equity to the company. Investors may include individuals and investment management companies. They make their investments through secondary markets such as the stock exchange.

User Decision Needs

Investors are interested in the firm’s financial statements and other information provided in the annual report to evaluate the performance of the business and determine the value of their investment. Every year Whole Foods Market, Inc. publishes its annual accounts for the year ending September 30. Moreover, they review the company’s management report to assess its ability to generate higher revenue and earnings in the coming periods. It allows them to decide to hold their investment to earn a better return.

Furthermore, investors would be interested in learning about different risks that could affect the company. Moreover, they may prefer to receive dividends from the company. Therefore, a firm’s reporting related to its financial performance provides all the necessary information investors require. The firm’s reported financials have a direct impact on stock performance. If the company maintained or increased its earnings during the period reported, then the stock prices are likely to increase and generate capital gains for investors.

Firm Type and Its Mode of Value Generation

Whole Foods Market, Inc. operates a chain of grocery stores and mainly sells food items. The company generates value by focusing on all primary and secondary activities of its value chain. The company sells high-quality organic products and ensures that natural ingredients are used in food items. The company’s customer service is highly responsive to achieve high customer satisfaction.

The management’s policies are supportive of employees and provide a friendly working environment. The company fulfills its corporate social responsibility by contributing positively to communities and also by promoting health education and healthy eating habits. The company is working on increasing the effectiveness of its supply chain relationships by creating partnerships with its suppliers. Furthermore, the company has a strong information technology system and network that connects all its stores and other business units.

Competitive Environment

The U.S. market for organic food has demonstrated strong growth in recent years. However, companies in the market face tough conditions, and they all compete on pricing, which is shrinking their profit margin. Therefore, companies must reduce their cost of operations by increasing their average sales per store or floor space. The major problem faced by the company was due to the entry of new companies in the organic food market.

Whole Foods Stores has taken several steps to take better control of its supply chain and reduce the prices of its products. For one, the company launched a value brand chain in 2015. The primary aim of the company was to expand its sales network and also reduce the cost of operations by opening a chain of small grocery stores. The management realized that there was a need to reduce the cost of operations as well as the prices of organic food items.

Financial Issues

The company has experienced declining profit margins over the last five years. The price competition affected the company’s position and reduced its earnings. The slowdown in business reduced the value of sales per store. Moreover, the company faced several scandals related to the use of inorganic procedures and ingredients in its products, and the demand for the company’s products has declined in recent years. The company’s earnings fell by 2.4% in the first quarter of 2017 (Assis 2017). Furthermore, the company’s stock price has been reduced by almost 60% from its high in 2014.

Summary of Financial Performance

Table 2 indicates that despite the increase in the company’s revenue in the last five years, its operating income and net profit declined.

Table 2

Income Statement Summary

2012 2013 2014 2015 2016
Revenue 11,699 12,917 14,194 15,389 15,724
Gross Profit 4,156 4,629 5,044 5,416 5,411
Operating Income 744 883 934 861 857
Net Income 466 551 579 536 507

Source: (Whole Foods Market Inc WFM 2017)

Table 3 indicates that the company’s cash declined significantly in the last five years. The current assets increased mainly due to the increase in accounts receivable. On the other side, the company’s liabilities increased substantially, and the shareholders’ equity declined. Overall, the company’s book value increased, but the table provided below indicates that the company faced major financial difficulties.

Table 3

Balance Sheet Summary

2012 2013 2014 2015 2016
Cash 1,220 1,023 743 392 730
Total Current Assets 2,103 1,980 1,756 1,544 1,975
Total Non-Current Assets 3,192 3,558 3,988 4,197 4,366
Total Assets 5,294 5,538 5,744 5,741 6,341
Total Current Liabilities 977 1,088 1,257 1,252 1,341
Total Non-Current Liabilities 515 572 674 720 1,776
Total Liabilities 1,492 1,660 1,931 1,972 3,117
Total Shareholders’ Equity 3,802 3,878 3,813 3,769 3,224

Source: (Whole Foods Market Inc WFM 2017)

PERL Framework

The financial ratio analysis based on time series is carried out in the following (Ryan 2004).

Performance Ratios

The performance ratios provided in Table 4 indicate that the company’s performance declined in 2016, except the return on equity. It could be noted that the company’s earnings fell in the last two years due to tough competition and pressure on the company to reduce its product prices. Furthermore, it could also be indicated that the cost of sales remained high, which forced the company to invest heavily in the integration of its supply chain to gain more control over the pricing of its products.

Table 4

Performance Ratios

Performance 2015 2016
ROCE (Return on Capital Employed) 19.2% 17.1%
Earnings Before Interest and Tax 861 857
Capital Employed (Total Assets – Current Liabilities) 4,489 5,000
ROE (Return on Equity) 14.2% 15.7%
Net Profit 536 507
Total Equity 3,769 3,224
RFCE (Return on Fixed Capital Employed) 9.5% 8.7%
Earnings Before Interest and Tax 861 857
Total Fixed Capital Employed 9,017 9,856
ROTA (Return on Total Assets) 15.0% 13.5%
Earnings Before Interest and Tax 861 857
Total Assets 5,741 6,341
Gross Margin 35.2% 34.4%
Gross Profit 5,416 5,411
Revenue 15,389 15,724
Operating Margin 5.6% 5.5%
Operating Profit 861 857
Revenue 15,389 15,724
Net Margin 3.5% 3.2%
Net Profit 536 507
Revenue 15,389 15,724

Efficiency Ratios

The efficiency ratios provided in the following table indicated that the company was successful at increasing its cost efficiency, labor asset turnover, and labor productivity as it continued to open smaller stores in 2016. However, there were problems related to its working capital management. It could be noted that the company took more days to receive payments from its debtors and settle payments to its suppliers.

Table 2

Efficiency Ratios

Efficiency 2015 2016
Cost Efficiency Ratio 1.01 1.06
Cost of Sales (Current Year) 9,973 10,313
Cost of Sales (Previous Year) 9,150 9,973
Revenue (Current Year) 15,389 15,724
Revenue (Previous Year) 14,194 15,389
Fixed Asset Turnover 1.71 1.60
Revenue 15,389 15,724
Total Fixed Assets 9,017 9,856
Labor Asset Turnover 3.61 3.68
Revenue 15,389 15,724
Labor Costs 4,260 4,268
Labor Productivity Ratio 0.17 0.21
Revenue 15,389 15,724
Total Number of Employees 91,000 76,300
Debtor Age 5.17 5.62
Trade Debtors 218 242
Revenue 15,389 15,724
Creditor Age 10.80 10.87
Trade Creditors 295 307
Cost of Sales 9,973 10,313
Stock Turnover (Days) 18.30 18.30
Inventory 500 517
Cost of Sales 9,973 10,313

Risk Ratios

The gearing ratio indicated that the company borrowed significant funds from debt providers in 2015-16. Its interest cover was sufficient to pay its interest obligations. However, the values of other ratios, including operational gearing and Beaver failure ratio, indicated that serious problems were faced by the company. The company urgently needs to reduce its fixed costs, including staff costs. Furthermore, it should focus on improving its operating cash flows to generate funds for investment rather than borrowing money from debtholders.

Table 3

Risk Ratios

Risk 2015 2016
Gearing 0.02 0.33
Long-Term Borrowing 62 1,048
Owner’s Equity 3,769 3,224
Interest Cover #DIV/0! 20.90
Earnings Before Interest and Tax 861 857
Interest Paid 41
Interest Gearing N/A 0.05
Interest Cover N/A 21
Operational Gearing 0.94 0.94
Fixed Costs 4,260 4,268
Operating Costs 4,555 4,554
Beaver Failure Ratio 0.72 0.11
Net Cash Flow 47 114
Total Debt 65 1,051

Liquidity Ratios

The company’s liquidity position in the short-term improved in 2016 as it could be noted that the values of both the current ratio and acid test were more than one. However, the value of the cash exhaustion ratio also highlighted the same problem of the company as it failed to reduce its cost of sales and operations. It could deplete the company’s cash in eight days. This is considered to be insufficient and a major weakness of the company.

Table 4

Liquidity Ratios

Liquidity 2015 2016
Current Asset Ratio 1.23 1.47
Current Assets 1,544 1,975
Current Liabilities 1,252 1,341
Acid Test 0.83 1.09
Current Assets 1,544 1,975
Inventory 500 517
Current Liabilities 1,252 1,341
Cash Exhaustion Ratio 5.78 8.34
Cost of Sales 9,973 10,313
Other Operating Expenses 4,555 4,554
14,528 14,867
Add: Depreciation 439 498
14,967 15,365
Average Daily Spend (365) 41 42
Cash in Hand 237 351
Operating Cash Flow to Maturing Obligations 376.33 372.00
Operating Cash Flow 1,129 1,116
Short-Term Obligations 3 3

Assessment and Conclusion

The company is facing tough market conditions and competition. Other companies are competing based on their cost efficiency, which in turn helps them to keep their prices low. The obvious problem that the company faced was its inability to control its costs and expenses. Therefore, the company should reduce the size of its stores and make them more efficient.

Furthermore, it should reduce the size of its workforce and improve its relationships with suppliers. The financial analysis indicates that the company’s performance and profitability weakened. Another problem is that the company’s solvency position was weak. The company’s strategy analysis indicates that it has taken several steps to improve its supply chain efficiency and reduce operational costs. From the investor’s point of view, it could be stated that there are no immediate risks of failure. Therefore, it is recommended that they should hold their investment in the company’s stocks.

Whole Foods Market’s Capital Structure

Whole Foods Market used both sources of finance, including debt and equity. The company’s stock symbol is WFM, and its stocks are listed on the New York Stock Exchange (NYSE). The number of outstanding shares was 326.1 million and 360.80 million in 2016 and 2015 respectively (Whole Foods Market – SEC Filings 2016 2016). The company announced a $1 billion buyback program in 2015-16, and the company issued four quarterly dividends in 2016, which totaled $0.54 per share. The company also issued a bond of $1.1 billion in 2015 (Murphy 2015). The company’s total liabilities in 2016 were $3.117 million, and the shareholders’ equity was $3.224 million (Whole Foods Market – SEC Filings 2016 2016). The capital structure of the company is determined as follows:

Capital Structure = Total Liabilities / Total Shareholders’ Equity (Brigham & Ehrhardt 2016).

Capital Structure = 3.117 / 3.224 = 0.96

The high value of the ratio indicates that the company made a significant shift from equity to debt. The obvious reason was that the cost of equity was higher than the cost of debt. The company benefited from the low cost of additional long-term borrowing. The interest paid on borrowing was also deducted from the company’s operating income. This implies that the company used borrowing to create a tax shield.

Equity Cost of Capital

Whole Foods Market, Inc.’s equity is comprised of common shares issued by the company in the capital market and retained earnings (Whole Foods Market – SEC Filings 2016 2016). The company’s equity cost of capital is calculated as the average of forwarding equity risk premium, cost of equity capital (American put), and cost of capital used in the dividend valuation model (DVM). The calculation is provided in the following manner:

Cost of Equity = (5.26% + 7.776% + 6.91%)/3 = 6.65%

Cost of Debt Capital and Market Value

The company issued a bond of $1.1 billion in 2015 to raise funds to fulfill its business needs. In the last five years, the company experienced many challenges, and its revenue and profit margin declined. The bond’s yield was reported at 3.93%, which is the cost of debt (Whole Foods Market Inc WFM 2017). The current market price recorded on March 1, 2017, was $30.67. The number of common shares outstanding was 326.1 million. The market capitalization of the company is calculated as follows:

Market Capitalization = Share Price x Number of Common Shares Outstanding (Brigham & Ehrhardt 2016).

Market Capitalization = $30.67 x 326.1 million = $990.5 million.

Weighted Average Cost of Capital (WACC)

The stock’s sensitivity is calculated by using the Beta Generator. The value of raw beta is 0.266.

Table 6

Stock Beta

Raw Beta 0.266 Dimson Beta -0.396
Adjusted Beta (BLUME) 0.540 Ryan Beta 0.973
Systematic Risk 1.53%
Unsystematic Risk 98.47% TRIANGULATED 0.372

This indicates that there is a low risk associated with the company’s stocks and implies that the stock price of Whole Foods Market is less sensitive to changes in the value of the market index. Therefore, investment in the company’s stocks is suitable for risk-averse investors. The effective tax rate of the company reported in 2016 is 38.5%, which was used for adjusting the cost of debt. The company’s WACC is calculated in the following table.

Table 5

WACC

Cost of equity (required rate of return) 6.65%
Number of equity shares in issue 326.1
Current share price 30.67
Equity capitalization 10001
Cost of debt capital 3.93%
Value of capital debt 990.5
Tax rate 38.5%
Market gearing ratio 9.01%
Weighted average cost of capital 6.26%

Source: (U.S. Department of the Treasury, 2017; Whole Foods Market Inc WFM, 2017; Whole Foods Market, Inc. (WFM) 2017)

Table 4 indicates that the WACC of Whole Foods Market, Inc. is 6.26%, which is the cost of funds estimated by the company for its projects. The company needs to generate a higher return on its capital employed than its WACC to increase the shareholders’ wealth.

Reference List

Assis, C 2017, Whole Foods shares fall after the company’s same-store sales decline, Web.

Brigham, EF & Ehrhardt, MC 2016, Financial management: theory & practice, Cengage Learning, Boston.

Murphy, M 2015, Whole Foods upsizes bond deal to $1B, Web.

Ryan, B 2004, Finance and accounting for business, Cengage Learning EMEA, London.

U.S. Department of the Treasury 2017, Resource center – daily treasury yield curve rates, Web.

Whole Foods Market – SEC filings 2016 2016, Web.

Whole Foods Market Inc WFM 2017, Web.

Whole Foods Market, Inc. (WFM) 2017, Web.