(Solved): Compute the WACC assuming a cost of debt of 9% (before tax). Compute the Ent value of EBITDA with E ...

Compute the WACC assuming a cost of debt of 9% (before tax).

Compute the Ent value of EBITDA with EBITDA = $ 1000.

Complete the table of Top Grocery Retailers (see line 443 of the f4120cases1 file)

Exhibit 7.5. See line 495. Complete the Market Cap, Total Debt, and Assessment of beta columns.

See line 481 re: Store Growth. Complete the 2012, 2013 columns for Whole Foods, Sprouts, Fresh Market, Kroger, Safeway, and Walmart

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Please answer the instructions above based on the information below, thank you for your help.

(Answer will be scanned, including within other Chegg answers, thumbs down for plagiarism)

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The latest numbers coming out of Whole Foods Market, Inc. (Whole Foods) in May 2014 took Deutsche Bank research analyst Karen Short and her team by surprise. On May 6, Whole Foods reported just $0.38 per share in its quarterly earnings report, missing Wall Street’s consensus of $0.41 and cutting earnings guidance for the remainder of the year. The company’s share price fell 19% to $38.93 the next day as Whole Foods’ management acknowledged that it faced an increasingly competitive environment that could compress margins and slow expansion. The only upbeat news was the 20% increase in the company’s quarterly dividend, up from $0.10 to $0.12 per share. Short and her team knew this was not the first time the market believed Whole Foods had gone stale. In 2006, Whole Foods’ stock had also declined 20% over fears of slowing growth and increasing competition, but had since bounced back and outperformed both its competition and the broader market (see the graph below for stock price performance). Nevertheless, it was time for Short and her team to discuss how the news altered their outlook for the company in a revised analyst report. The main point of discussion would certainly be whether Whole Foods still had a recipe for success.

The U.S. grocery industry as a whole had historically been a low-growth industry, and, as a result of fierce competition, had typically maintained low margins. In 2012, the industry recorded over $600 billion in sales, a 3% increase from the previous year. Real demand growth was strongly tied to population growth, and consensus estimates for nominal long-term growth rate were between 2% and 3%. Key segments included conventional grocers such as Kroger, Publix, Safeway, and Albertsons; supercenters such as Wal-Mart and Target; natural grocers such as Whole Foods, Sprouts Farmers Market (Sprouts), and The Fresh Market (Fresh Market); and wholesalers such as Costco and Sam’s Club. Conventional grocers remained the primary destination for shoppers, but competition from Wal-Mart, wholesalers, and other low-price vendors had driven down conventional grocers’ share of food dollars for over a decade; for example, Wal-Mart was the largest food retailer in the United States in 2014, with 25% market share. Exhibit 7.2 provides market share information for the U.S. grocery market. The narrow margins and limited growth opportunities favored large competitors that could leverage efficiencies in purchasing and distribution to pass savings on to the consumer. As a result, many small competitors had been acquired or forced to close. Consumers were extremely price conscious and came to expect promotions (which were largely funded by manufacturers), and most shoppers did not have strong attachments to particular retail outlets.

Given this environment, companies relentlessly searched for opportunities to achieve growth and improve margins. Many grocers had implemented loyalty programs to reward repeat shoppers, and most were trying to improve the in-store customer experience, for instance by using self-checkout lines and other operational adjustments to reduce checkout times, a source of frequent complaints. Given the high percentage of perishable goods in the industry, supply chain management was essential, and companies were using improved technology to more efficiently plan their inventories. Grocers also began promoting prepared foods, which could command higher margins and reach consumers who did not regularly cook their own meals. Finally, most major grocers offered private-label products, which allowed them to offer low prices while still capturing sufficient margins.

Despite operating in a competitive and low-growth industry, natural grocers had grown rapidly over the past two decades. Increasingly health-conscious consumers were concerned about the source and content of their food, which fueled natural grocers’ sustained growth (over 20% per year since 1990) despite their comparatively higher prices. In 2012, natural and organic products accounted for $81 billion in total sales in the United States, a 10% increase from the previous year. Organic products, which were more narrowly defined than natural products, accounted for about $28 billion of these sales and were expected to top $35 billion by the end of 2014. Exhibit 7.3 provides growth forecast and share data on the natural and organic segments. As of 2014, 45% of Americans explicitly sought to include organic food in their meals, and more than half of the country’s 18–29-year-old population sought it out. By specializing in such products, natural grocers were able to carve out a profitable niche: the three leading natural grocers (Whole Foods, Sprouts, and Fresh Market) had EBITDA margins of 9.5%, 7.7%, and 9.1% respectively, whereas Kroger, the leading conventional supermarket, had an EBITDA margin of only 4.5%. Exhibits 7.4 and 7.5 contain operating and financial information for selected companies in the U.S. grocery industry.

As expected, the segment’s attractiveness sparked increasing competition from both new entrants and established players from the other competing segments. Wal-Mart, Kroger, and others launched organic offerings targeted at health-conscious consumers, often at a much lower price point than similar products at natural grocers. While Whole Foods, other natural grocers, independent retailers, and food cooperatives were the primary source of organic products in the 1990s, by 2006, half of the country’s organic food was sold through conventional supermarkets. By 2014, organic products were available in over 20,000 natural food stores and nearly three out of four conventional grocers.

Even in the face of this competition, Whole Foods maintained a position as the market leader for the natural and organic industry. As many grocers joined the natural and organic bandwagon, Whole Foods defended against misrepresentative claims. Whole Foods had recently introduced a system to rate fresh produce on a number of criteria, including sustainability and other characteristics important to natural and organic customers. The company’s website listed over 75 substances that were prohibited in all of its products and published additional measures for meat, seafood, and produce selection to ensure consumers had insight into the quality of their food. Whole Foods was the only U.S. retailer that labeled genetically modified foods, an area of some concern to health-conscious consumers.

Despite its remarkable growth, the natural and organic industry was not without its critics. Several academic and government studies had concluded that organic products were not significantly more nutritious than nonorganic goods and claimed that the inefficiency of organic production could harm the environment. Moreover, the continuing lack of official legal definitions of terms such as “natural” arguably made them effectively meaningless: one botanist argued the segment was “99% marketing and public perception.”

Whole Foods traced its roots to 1978, when John Mackey and Renee Lawson opened a small organic grocer called SaferWay in Austin, Texas. Two years later, it partnered with Craig Weller and Mark Skiles of Clarksville Natural Grocery to launch the first Whole Foods Market, one of the country’s first natural and organic supermarkets. In 1984, the company began expanding within Texas and in 1988 made its first move across state lines by acquiring the Louisiana-based Whole Foods Company; the next year it launched its first store in California. The company went public in 1992 and grew rapidly during the 1990s through both new store openings and acquisitions. Whole Foods launched its first international store in Canada in 2002 and acquired a natural supermarket chain in the United Kingdom in 2004. The company had consistently maintained high growth throughout the new century by increasing same-store sales and expanding its store count; same-store sales grew more than 5% in every year except 2008 and 2009, when the global financial crisis brought America into a severe recession. By 2013, the company’s growth strategy had moved away from acquisitions, and management saw improving same-store sales and continued new openings as its primary growth opportunities. Same-store sales—the most important growth criteria Wall Street used to evaluate retailers—had grown by at least 7% every year since 2010, far above other established grocers’ growth rates even after it began expanding its natural and organic offerings. The company had done all of this with no debt financing. Looking forward, Whole Foods management planned to eventually operate over 1,000 stores, up from the 362 it operated as of the end of fiscal year 2013. Exhibit 7.6 contains store count and same-store sales growth history for Whole Foods and other industry players.

Whole Foods positioned itself as “the leading retailer of natural and organic foods” and defined its mission as promoting “the vitality and well-being of all individuals by supplying the highest quality, most wholesome foods available.” The company’s sole operating segment was its natural and organic markets and nearly 97% of its revenues came from the United States. By 2013, the average Whole Foods store carried 21,000 SKUs and approximately 30% of sales outside the bakery and prepared-food segments were organic. Whole Foods reported $551 million in net income on $12.9 billion in sales in 2013, making it the clear leader of natural and organic grocers even though its numbers were still rather small compared to Kroger’s net income of $1.5 billion on more than $98 billion in sales.

From the bears’ perspective, the natural and organic market was becoming saturated as more companies offered organic products at lower cost. This competition would soon compress Whole Foods’ margins, while at the same time stealing market share and causing same-store sales to slow or even decline. Several analysts had downgraded Whole Foods after the company issued its disappointing quarterly results. A report put out the previous week by another bank noted that 85% of Whole Foods’ stores were within three miles of a Trader Joe’s—a privately owned natural grocer—up from 44% in 2005; similar overlap with Sprouts had grown from 3% to 16% and with Fresh Market from 1% to 14%. Moreover, Whole Foods was running out of dense, highly educated, high-income neighborhoods to open new stores in, which could either force the company to rely more on low-price offerings or slow its rapid expansion. Such a shift in strategy could take the company into uncharted territory and risk its reputation as a premium brand. Finally, the bears were concerned that the new competitive reality would cause the market to fundamentally revalue Whole Foods. The company had long traded at a substantial premium, at times exceeding Kroger’s market value, despite the latter company’s substantial size advantage (compared to Whole Foods, Kroger had 7.3 times as many stores that generated 7.6 times as many sales and 3.6 times as much EBITDA). Such a premium could only be justified if Whole Foods could continue growing, both at its existing stores and in terms of its overall footprint. The team noted that even if it cut the price target from $60 to $40, Whole Foods would still trade at a premium to its competitors in the conventional grocers’ segment.

EXHIBIT 7.1 | Share Price Performance of Whole Foods Market Indexed to S\&P 500 Index (January 2005 to April 2014) Data source: Yahoo! Finance, author analysis. EXHIBIT $$7.2$$ | Select Market Share Data Source:Market Share Reporter (Farmington Hills, MI: Gale, 2014) and author analysis. Data source: Deutsche Bank Research; Food Marketing Institute. Note: "Other natural \& organic" is composed of Sprouts and Fresh Market. "Conventional grocer" is composed of Kroger, Safeway, and SuperValu. "Supercenters and wholesalers" is composed of WalMart and Costco. Source: Company SEC filings, 2003-2013. EXHIBIT 7.5 | Selected Financial Data for Comparable Companies (in millions of USD, except percentages, ratios, and per share data; financial statement data as of fiscal year 2013) Data source: Company SEC filings; Deutsche Bank Research; Food Marketing Institute. EXHIBIT 7.7 | Deutsche Bank Model (in millions of USD, except per share figures) Data source: Company financial reports, Deutsche Bank research, and author estimates. EXHIBIT $$7.8$$ | Demographic and Capital Markets Data Data sources: Bloomberg and U.S. Census Bureau. 385 Case 7: Whole Foods Market $$20\%$$ increase in quarterly dividend. The U.S. grocery industry is a low-growth industry Long-term growth rate between $$2\%$$ and $$3\%$$. Companies relentlessly searched for opportunities to improve profit margins. The natural and organic market was becoming saturated as more companies offered organic products at lower cost. Qiestions 1. What are some of the best principles for financial forecasting ? 2. What is occurring at Whole Foods, and how does that affect Karen Short? See Exhibit $$7.6$$ Whole Foods Market: Same Store Sales Growth Q1. Assess the future potential of the natural and organic foods industry. Do you believe that growth will be maintained? Q 2. What are the benefits to Whole Foods of the Amazon acquisition ? Earnings miss Earnings per share < Forecasted earnings per share. Grocery Industry low margins low growth population growth drives profits long term growth rate $$2?3\%$$ Competitors Traditional Supermarkets Kroger, Pubix, Albertson's Supercenters Walmart and Target Natural and Organic Whole Foods, Fresh Market growth customers increasingly health conscious higher priced products competing on price prepared foods, private-label products higher margins Share price performance high volatility risk EBITDA Earnings before interest taxes, depreciation and amoretization \begin{tabular}{l|l|l} operating income efficiency of operations & $$7?9\%$$ \\ \hline \end{tabular} natural and organic has higher EBITDA than traditional supercenters. $$4\%$$ volatile sales risk Whole Foods market leader first mover Established in the natural and organic category. rigorous standards to maintain position in the natural and organic segment. Page 116 Same store sales $$5\%$$ 421 Page 116 422 Same store sales $$5\%$$ 423 Reasons for the earnings miss 424 1. High prices promotional sales, private labels Market Share Changes Traditional Supermarkets (Ending value - Beginning value)/Beginning value $$?7\%$$ (Ending value - Beginning value)/Beginning value $$8\%$$ Convenience Stores (Ending value - Beginning value)/Beginning value 3\% Wholesale Clubs (Ending value - Beginning value)/Beginning value $$6\%$$ Drug Stores (Ending value - Beginning value)/Beginning value 7\% Mass Merchandisers (Ending value - Beginning value)/Beginning value $$?36\%$$ Limited Assortment Frocery Stores (Ending value - Beginning value)/Beginning value $$37\%$$ Dollar Stores (Ending value - Beginning value)/Beginning value \begin{tabular}{l|l|} \hline 442 & \\ 443 & Top Grocery R \\ 444 & Wal-Mart \\ 445 & Kroger \\ 446 & Costco \\ 447 & Target \\ 448 & Whole Foods \\ 449 & \end{tabular} $$5\%$$ 450 Key question - why did Whole Foods have an earnings miss Overly optimistic sales forecast $$45211?14\%$$ EBITDA margin $$9\%$$ 1. Market saturation. Walmart has volume purchasing. 2. Fewer high-income neighborhoods Traditional market segment had more competitive choices. 458 3. Stock trading at a high price. Stock overpriced. 460 Positive growth factors 461 1. Large volume of products. Match Kroger on 10,000 items. 462 2. Private-label products. Cheaper, WF more price competitive. Permits store openings beyond their traditional market segment. 463 Exhibit 7.3, page 121 464 Conventional Supermarkets Flat sales No new store openings $$46515\%$$ growth rate in stores for natural and organic. 466 Natural and organic - very few stores in relation to conventional supermarkets. 467 Exhibit $$7.5$$ 468 Sales 469 Conventional Supermarkets price competition supercenters offer greater price competition than supermarkets. Exhibit $$7.6$$ Store Growth Whole Foods \begin{tabular}{|r|r|r|r|r|r|} $$2008\%$$ & 2009 & 2010 & 2011 & 2012 & 2013 \\ \hline 0 & $$0.032727273$$ & $$0.052816901$$ & $$0.04013378$$ & & \\ \hline \end{tabular} 84 Sprouts 885 Fresh Market \begin{tabular}{rr|r|r|} 0 & $$0.111111111$$ & $$0.075$$ & $$1.39534884$$ \\ \hline 0 & $$0.069767442$$ & $$0.086956522$$ & $$0.13$$ \\ competitive threat-higher forecasted growth for Fresh Market \end{tabular} $$\begin{array}{ll}7& \text{ Kroger }\\ 8& \text{ Safeway }\\ 9& \text{ Walmart }\\ 0& \text{ Same Store Sales Growth }\\ 1& 7\%<\text{ forecast of }11?14\%\end{array}$$ 492 Costco averages hogher same store sales growth. Competitive threat. 493 Page 123 494 495 Whole Foods EBITDA \begin{tabular}{|l|c|c|c|c|c|} \hline 9. Efficient store operations; comparable to the market leader. & Mkt cap Size & Total debt & $$0.75\%$$ & $$0.7$$ typical grocery & low risk \\ \hline \end{tabular} 496 Conventional Grocers 497 Kroger 498 Safeway 499 Supervalu $$4\%$$ $$4\%$$ 500 Supercenters 501 Wal-mart 502 Target $$8\%$$ Costco $$4\%$$ Page 125 \begin{tabular}{r|r} \hline 2011 & 2012 \\ \hline $$800\%$$ & 100 \\ \hline $$3\%$$ & $$9.02\%$$ \\ \hline $$3\%$$ & $$2.66\%$$ \\ \hline \end{tabular} Common size statement Sales Dep \& Amort Net Income 1222 actual 2013 Table 7.5, page 123 Ent Value to EBITDa Enterprise value is 11 times operating income. 14481 , page 123 , market cap of equity Page 125 \begin{tabular}{l|l|l} \hline Sales Growth & decline in sales in 2013; & Forecasts may be unrealistic. \\ \hline Current Asset turnover & unstable & Forecasts may be unrealistic. \\ \hline Net PPE & increase & Increase in PPE may not be justified. \end{tabular} Cost-of-Capital Estimation See pages 125-126, Table $$7.5$$ Page 126: compute cost of equity using multiple risk free rates. Whole Foods \begin{tabular}{r|r|r} 2011 & 2012 & 2013 \\ 8 & 8 & 7 \\ $$5.1$$ & $$9.7$$ & $$10.7$$ \\ $$5.4$$ & $$5.7$$ & $$3.2$$ \\ \hline 6666667 & $$7.8$$ & $$6.966666667$$ \end{tabular}