Ratings Agency Thought: Should Whole Foods Still Be Junk-Rated? (WFM, KR, SWY, WMT)

It seems that being a junk bond credit investor still allows you to pick from a whole slew of companies that should not be junk bonds.  Unfortunately, you as an investor will probably never really get to invest in any of Whole Foods’ bonds or credit products.  A new research report from Standard & Poor’s today shows that the credit rating agency upgraded the rating of Whole Foods Market Inc. (NASDAQ: WFM).  The upgrade is based upon better performance than expected and strong operating trends enabling the company to pay down its term loan faster than expected.

Whole Foods’ corporate credit rating was raised by one notch to “BB+” from “BB.”  It was also given a stable outlook, implying that no more upgrades to the credit ratings are imminent even though S&P clearly shows that the stable rating is due to expected good profitability and credit metrics continuing to improve over the near-term.

Once upon a time, we showed how Kroger Co. (NYSE: KR) was beginning to go after Whole Foods by offering many of the exact same organic or premium items.  The adjustments made by WHole Foods have been made.  Another trend we have observed through time is that as Whole Foods has grown and grown that it has had to lower its organic offerings and go to more conventional items. It is Safeway Inc. (NYSE: SWY) and Kroger which have the biggest exposure to raw food inflation by our take.  Lastly, the move of organic food sales by Wal-Mart Stores Inc. (NYSE: WMT) has only added to the organic pool with higher margin sales rather than acted as a true hit to Whole Foods. 

S&P called Whole Foods the leader in organic and natural foods retailers and noted that this segment has outperformed traditional grocery stores.  S&P believes that will also continue.  Nothing really new to share there.

The catch is that S&P said it views the risk profile as fair because of the competitive nature of the industry, and it also noted food inflation could limit the recent trends.  It ends by calling Whole Foods’ “financial risk as significant.”

Our take is quite a bit different and we think that S&P is being too conservative here.  24/7 Wall St. does not consider Whole Foods an organic and natural product grocery store any longer.  Whole Foods is simply a luxury product seller.  How many late sovereign ratings have come out of the ratings agencies? 

Our take is that Whole Foods is a late upgrade.  The corporate credit rating should be higher.  S&P has “BBB-” as the lowest rung of investment grade.  This is still junk-rated if you consider that.  Whole Foods is well enough established that it has been able to withstand the worst of the recession rather easily and it has many significant market opportunities that it has not even entered into with some smaller store formats.

Whole Foods shares are trading up around $62.00 and its 52-week trading range is $33.96 to $66.87.  Thomson Reuters has a consensus price target for the stock of $65.64.  It may be too late to buy Whole Foods stock on a risk-reward basis, but its corporate credit rating should probably not be junk-rated as of 2011.  That is our take anyway.

JON C. OGG