Quality Earnings, Quality Food: Whole Foods Market (WFM)

Quality Earnings, Quality Food: Whole Foods Market (WFM)

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Healthier eating habits have been going mainstream in recent years, with natural foods taking increasing market share from conventional grocers. That’s not necessarily been good news for Whole Foods Market (WFM), the company that brought organic and natural foods to scale. Trader Joe’s, Kroger, and Walmart are eating into WFM’s market share and addressing the inflated costs of going natural by lowering prices on organic produce. WFM has had a rough year, and its stock price is currently trading at a four-year low.

The company has been buffeted by bad headlines. In 2015, the company faced allegations of overcharging customers in New York for bulk foods and has dealt with several outbreaks of listeria. After adding 9,000 jobs in 2014, WFM in September announced plans to lay off 1,500 employees and in November adjusted the number upward to 2,000. Last quarter, WFM bowed to pressure from activists and announced it would stop selling products made by inmates (tilapia and goat cheese produced through a Colorado inmate program). And the company is facing a PETA lawsuit alleging that product labels identifying meat as humanely farmed were misleading consumers. In addition, Clean Yield has filed a shareholder proposal calling for stronger palm oil policies.

But one could argue that these factors have had a minor impact on the company’s recent stock performance. The real driver behind WFM’s dramatic downward price adjustment is the combination of a previously overvalued stock and a deceleration in growth due to the stiff competition in the natural foods sector. Entering 2015, WFM was on a tear from a 35-month low of $36 in October 2014, jumping 50% in just four months and peaking just shy of $57 in late February.

In May, WFM reported disappointing same-store-sales growth of less than 3% (down from the historical average of 7.1% between 2010 and 2014), and the stock was hit hard. In July the company reported lower-than-expected earnings and flat same-store growth, causing the shares to drop 10%. And in the most recent quarter, WFM missed guidance on all metrics, including sales, earnings, and same-store sales.

However, Clean Yield has not lost confidence in WFM. While we may be selling (and later repurchasing) WFM for tax loss purposes in some accounts, we continue to believe in the long term prospects of the company. Historically the company has been well managed and generated good returns on shareholder capital. This is not the first time WFM has been through a challenging period, and each time, it has adjusted its strategy and pulled through. This time, WFM has laid out a plan to turn itself around through expense reductions, as well as investments in lower prices, marketing, communication, and technology. The company is also implementing a $1-billion share repurchase program (about 10% of its shares outstanding at today’s levels), which should support the stock price.

Despite an overall drop in same-store sales, new stores’ sales are doing well. And this year, WFM introduced a new, smaller store format similar to Trader Joe’s and called 365 by WFM, targeting millennials in urban markets. Other companies with the same idea include Target with its CityTarget stores, Wal-Mart with its Neighborhood Market, and Ahold’s foodie-focused bfresh™ stores. It remains to be seen whether the new stores will drive growth or erode sales in existing WFM stores.

20151123WFM

While there are no quick fixes for the company’s challenges, WFM is financially solid and has one of the best balance sheets in the industry. Continued secular growth of the organics segment should support the company’s recovery and long-term health.

 

Whole Foods

Price: $30.00

Stock 52-week Low–High: $28.73-$57.57

Market Capitalization: $10.22 billion

Earnings Per Share (EPS):

2016 est. $1.74
2017 est. $1.84

Price/Earnings (2015): 20.12x

Projected 3–5 Year Annual Earnings Growth: 10.7%

Dividend Yield: 1.81%

Risk: Average

Website: https://www.wholefoodsmarket.com/

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