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Whole Foods’ Margins and Profitability May Continue in 4Q16

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Higher expenses put WFM’s profits under pressure

Whole Foods Market’s (WFM) sales comps and gross margin have come under pressure as the company has been following a value strategy to lift sales. The company is actively adjusting its operating model to a lower margin and lower cost structure.

In 3Q16, WFM’s gross margin dropped 89 basis points to 34.7%, primarily reflecting the company’s value efforts and price investments.

SG&A (selling, general, and administrative) expenses also rose 11 basis points to 28.5% of sales in 3Q16. Though the company achieved some improvement in salary expenses as a result of its ongoing expense control initiatives, it was more than offset by higher healthcare, depreciation, marketing, and technology investments. As a result, WFM’s operating margin fell 116 basis points to 5.6% of sales in 3Q16.

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Comparing profitability to peers

Though WFM’s profitability has been impacted by the ongoing competition in the natural food industry, the company continues to display one of the best margins in its peer group. The company’s operating margin of 5.6% is better than that of Kroger (KR), Supervalu (SVU), Walmart (WMT), and Costco (COST), which achieved operating margins of 3.5%, 2.6%, 4.6%, and 3.2%, respectively, in their last reported quarters. WFM only trails Sprouts Farmers Market (SFM) in terms of profitability. SFM achieved an operating margin of 7.8% in its last reported quarter.

Looking ahead in 4Q16

The company expects the ongoing headwinds from its value strategy and disinflation to affect its top line in 4Q16. It has predicted sales growth of 2% and diluted earnings per share of $0.23 to $0.24 for 4Q16.

ETF investors seeking to add exposure to SVU can consider the First Trust Consumer Staples AlphaDEX Fund (FXG), which invests 1.6% of its portfolio in the company.

To learn about the company’s stock market performance versus peers, move on to the next part of this series.

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