It’s pretty difficult to maintain 10%+ growth rates in the grocery business. However, that is what Whole Foods Market (WFM) has been able to do for some time. In fact, earnings growth rates over the past five years have averaged 29.1%, not too shabby considering the average is closer to 13% across the industry.
Whole Food Market’s growth and profitability trends aren’t obvious if you look at the chart. WFM is down 40% from its 52-week high, which also happens to be its all-time high. This kind of decline has happened to WFM before. The sub-group it belongs to is new(ish) – at least at a national level – and there is a lot of uncertainty about how far they can grow. It’s difficult to model a company like this, so large over-corrections in both directions are fairly common.
Traders have become a little nervous after same store sales flattened and many analysts are speculating that there aren’t enough additional high-end markets to expand into domestically. These factors could be an issue that prevents WFM to reach its prior highs. However, we are taking the same approach to the stock that we did the last time we recommended Whole Foods Market in 2012. There is an opportunity for a “base hit” into May’s gap before investors have to make a decision about holding for a longer period.
The recent decline isn’t just about growth rates. It’s probably a combination of other fundamental and technical factors. As you can see in the next chart, Whole Foods Market’s price started to decline when its operating markets flattened and cooled off. Prior to last year’s third quarter, operating markets had been on a tear. Something similar (if a little more dramatic) happened in 2007, as well.
Whole Foods Market (WFM)
From a technical perspective, there are two things you should notice in the next chart for Whole Foods Market. First, the stock was clearly overbought in 2013 (regardless of slowing growth) as evidenced by the head and shoulders technical pattern from June 2013 through May 2014. The pattern broke, retested and competed its objective (-21.7%) in June 2014. This technical pattern is historically reliable and let some of the pressure out of the stock.
Whole Foods Market (WFM): Chart Courtesy of eSignal
You can also see a bullish divergence emerging now that the head and shoulders pattern has completed. You may want to click on the chart to see a full size version. The first target following the divergence is the mid-point at $42.50 and the second target is the top of May’s gap. If the stock “fills the gap,” prices could certainly rise higher, but we would suggest sticking to the near term targets for now.
From a fundamental perspective, Whole Foods Market still has a declining margin problem. Competition is increasing and it seems unlikely they will be able to stage another rally like they did through the early 2000’s and from 2008-2013. However, from a value perspective, the company is trading for much less than it did in 2006, when it topped out at these same prices. Traders tend to over-react to bad news and this is one of those situations where a reversion to the mean is likely.
We don’t expect Whole Foods Market to hit $65 gain until they are able to show that same store sales can grow at previous rates or expansion is accelerated. However, it’s hard to see how a profitable company, trading at lower multiples than it has in 10 years, can’t attract buyers in a market where investors are flooding into doomed turnarounds – Radio Shack (RSH), Office Depot (ODP), Bed Bath and Beyond (BBY), etc.
We like the opportunity for buying a short-term position in Whole Foods Market stock at current levels that could turn into something longer lasting if WFM is able to show a positive change in its growth trends next quarter.
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