Whole Foods' Unholy Mess

The factors driving the grocery business at the moment are ones that could easily change in fairly short order. Commodity prices are falling, but underlying economic forces dictate that they will rise again. People are trading down from Whole Foods to Safeway and from Safeway to Kroger, but they'll go back to their favorite stores, and their favorite organic cheeses, once the recession is over.

Or will they? Much depends on how long the downturn lasts and how bad it gets. If the recession is deep and long, newly acquired shopping behaviors might become more or less permanent, and commodity prices might stay down longer than anticipated. Some people will get used to shopping at discount grocers and will be slow to return to their favorites. That scenario is particularly bad for high-end grocers.

No grocer is more at the mercy of the economy's whims than Whole Foods. And no grocer is more exposed to long-term harm from what will hopefully be a short-lived recession.

"We're in very uncertain economic times, and we're not certain what's going to happen," Whole Foods Chief Executive John Mackey told analysts during the company's earnings call on Wednesday, when we learned that the company's profits were down 96 percent in its third quarter.

That same day, Whole Foods announced that private-equity outfit Leonard Green & Partners will inject $425 million in capital into the grocer. Initially, investors greeted that news with a rally. Then it sank in that the preferred stock Leonard Green bought is convertible into common shares that would give it a 17 percent stake, diluting the stakes held by existing stockholders. Shares on Friday were trading nearly 77 percent lower than a year ago.

It also sank in that going begging for capital isn't a good sign for the company. It will pay an 8 percent dividend on Leonard Green's preferred shares. "Whole Foods provided further evidence that it has serious cyclical and structural issues," wrote Credit Suisse analyst Edward Kelly.

Those structural issues show that the economy isn't the only thing hurting Whole Foods. The company is responsible for many of its own problems. Buying Wild Oats was a serious misstep that will haunt the company for years to come. Also, during a time when it should be retrenching and scaling back, its hands are tied by leases it has signed on 66 properties where it will open new stores over the next four years. It's terminating as many leases as it can, but that's expensive, too.

Still, if the recession is short-lived enough, Whole Foods should come out the other end in decent shape. Joseph Agnese, an analyst at Standard & Poor's, told BusinessWeek that he's optimistic. "The trend among consumers is still to eat healthier and go organic," he said.