Whole Foods (WFM) has provided investors with a real conundrum over the past few years. I’ve written extensively about it, and want to evaluate my calls.
In 2012, I said it was a great company, but too expensive to buy. I said it again a year later. Then I told you to sell again in November 2013. In various places, I’ve since said that getting in somewhere in the $30s might be a good idea, especially if you scale in a bit at a time, such as whenever the stock fell another 10%.
Well, here we are at $32, and the question is whether Whole Foods stock is a buy at these levels or is a trap.
My theory has always been that Whole Foods attracts a specific, upscale shopper. It’s called “Whole Paycheck” for a reason. It is the equivalent of retail shoppers who only shop luxury brands. They are not going to leave Tiffany (TIF) to shop at J.C. Penney (JCP). That’s just not how upscale people roll.
But now it appears that may not be true when it comes to food.
I think Whole Foods stock may be facing issues from two arenas: unexpected competition and a weak economy. Let’s take the competition issue first.
The Whole Truth
I’ve said before that Walmart (WMT) couldn’t compete with Whole Foods. That’s probably true. People who shop at Whole Foods are unlikely to go near Walmart for whatever organic offerings they had.
However, they would go near a Kroger’s (KR). WFM has a good selection but they don’t carry every last thing, and that means that most shoppers probably also shop at conventional groceries, just as I do. Then came word that the Organic Trade Association estimates some 78% of Americans purchase organics at conventional stores.
Ah-ha! So I didn’t account for that with WFM.
Perhaps Kroger’s Simple Truth in-house organic brand is indeed filling the demand for organics at lower prices. Apparently, that brand hit $1 billion in annual sales in just two years. That’s a fraction of Whole Foods’s $14 billion, but still, a significant number anyway you slice it.
Another issue is that the economy is weak. Rather than downgrade to another retailer, luxury retail consumers simply don’t purchase stuff when things get really bad. But everyone needs to eat. If they can get the same, or similar, organics for less at Kroger, they will, and maybe even save a trip to a second market.
While upscale folks aren’t hurting as bad as the middle and lower classes, consumer sentiment still stinks, and that may be a factor.
So I’m not as sanguine about the near-term prospects for WFM. Not that this is a catastrophe by any means, but let’s look at the numbers. The stock is at $32. Fiscal year 2016 estimates are $1.78, up only 7% year-over-year from FY15. Long-term growth is pegged at 11.55%. Add in the 1.62% yield, and you get growth of 13%. It has about $1.94 per share in cash, so the effective stock price is $30.06.
That means Whole Foods stock trades at 16.8 times estimates. With 13% growth, I would add a 10% premium for it’s $691 million in net cash and another 10% for its brand name. So paying around 15 times earnings is the absolute max … and we are just about there.
I think Whole Foods stock’s highflying days are over, although I would never count out a brand and market reboot. And I wouldn’t bet against the CEO, either. But with that said, I think Whole Foods stock is probably a hold right now. I think it would make for a reasonable long-term purchase for those expecting 15% growth in the stock going forward.
I think sentiment is weak, however, which means I wouldn’t open a full position. Instead I would open a fractional one and/or sell naked puts.
Lawrence Meyers does not have a position in any company mentioned.
