by Jane Hoback

A sagging economy dragged down Whole Foods Market Inc.'s third-quarter profits in both the U.S. and the U.K., as shoppers spent less on organic produce and gourmet food.

And while the current slump in housing prices and $4 a gallon gas may force consumers to pull back from buying natural products, analysts say the long-term outlook for the industry is strong.

"We believe the market niche for high-quality natural and organic food will expand over time [even if it is a tougher sell today]…," Mark Miller, an analyst at William Blair & Co., wrote in an August research note.

Austin, Texas-based Whole Foods, the largest U.S. natural-foods grocer, reported earnings down 30 percent, or 35 cents a share, from $49.1 million in the third quarter of 2007 to $33.9 million, or 24 cents a share, for the three months ending July 6. Revenue rose to $1.84 billion from $1.51 billion a year earlier. Analysts expected, on average, profit of 31 cents a share on revenue of $1.9 billion. Sales growth at stores open at least a year plunged to 2.6 percent from 6.7 percent the previous quarter.  

"Our business model has been highly successful, and we remain very bullish on our growth prospects…," said Whole Foods CEO John Mackey in a press release. "However, the challenging economic environment appears to be negatively impacting our sales."

The company, which has 271 stores, said it will cut the number of planned store openings to 15 by September 2009 from the 25 to 30 announced in May. It will cut capital spending that doesn't involve new stores by 50 percent. It has implemented "certain cost containment measures" and suspended its quarterly dividend "for the foreseeable future." Whole Foods also lowered its outlook for 2009, saying it expects sales growth of 6 percent to 10 percent for the year, down from its previously stated 25 percent to 30 percent.

"Just as the company's double-digit same-store sales growth from 2004 to 2006 caused the company to accelerate its new-store development and expand into the United Kingdom, the weaker current trends are causing management to pull back on capital spending today, which does set the stage for improving returns in the business when the economy improves," Miller wrote.

Whole Foods reported that its operations in the U.K., where it owns six stores, lost $18.4 million, or 9 cents a share, in the last four quarters. But Mackey said he expects to trim losses to $13 million in fiscal 2009, $7 million in fiscal 2010 and to break even in 2011.

"We initially lost money when we entered into Canada as well; however our stores there continue to grow and are now very profitable, earning $14.6 million before taxes over the last four quarters," Mackey said in the release. "We believe the long-term growth potential in the U.K. is much greater than in Canada. We are evaluating all aspects of our operations in the U.K., with the intent to improve our results over the short term and deliver strong returns over the long term."

And working to change its image as a strictly high-end grocer, Whole Foods launched its "Whole Deal" program in July, directing customers to discounts and other deals throughout the stores.

Edward Aaron of RBC Capital Markets in Denver sees a difference between behemoth Whole Foods and the rest of the industry."The industry's growth is not decelerating as fast as Whole Foods' (growth) is decelerating," Aaron said. "Whole Foods is more of an aspirational store. And the demand for aspirational products is being hit harder in this economic environment."

Whether smaller chains and independents will be hit as hard isn't clear. "Certainly, any time the bellwether has issues, it's worth paying attention to. Any retailer who can project an image of value and quality is very well-served," Aaron said.

In an Aug. 6 research note, Citigroup's Gregory Badishkanian wrote, "Although consumers have been trading down from restaurants to grocery in a weak economy, we are seeing some trading down within the natural grocery channel as well. This appears to have negatively impacted (Whole Foods), which is a higher price perceived retailer. Business trends, however, of natural/organic appear to be strong with independents and conventional supermarkets…"

And for the natural product industry as a whole, Badishkanian wrote that he sees "decent growth," particularly for companies such as Hain Celestial Group and UNFI, which both are expected to report healthy organic sales.

Jane Hoback is a Denver-based freelance writer.