Usually, when one writes this type of article, the author will trot out several reasons backing up their recommendation to buy this or that particular stock. It’s the nature of the beast. However, I’m not going to do that. Instead, I’m going to list several reasons some experts think you should sell Whole Foods Market, Inc. (WFM) and then refute each one of them.
By the end, I think you’ll be able to make up your own mind who is right — the bulls or the bears.
Reason No. 1 to Sell WFM
Whole Foods’ stock lost 2% June 15 on news the FDA are all over the company because of a long list of problems at a Massachusetts plant the company uses to manufacture ready-to-eat products for its stores.
If you’re a germaphobe this news will definitely turn you off the store and WFM stock. For the rest of us, it’s up to every individual who shops at Whole Foods or is considering shopping there to determine the seriousness of these complaints.
The FDA believes the plant’s lack of cleanliness and sanitation lends itself to the growth of Listeria at the plant. This is serious stuff. We all know the Chipotle Mexican Grill, Inc. (CMG) story.
Silver Lining: What doesn’t kill you makes you stronger. The company has taken steps to fix this and although the FDA believes problems still exist at the plant, Whole Foods will do what it must in order to maintain its reputation as a healthy market.
In the meantime, this exercise becomes a learning opportunity for the company. I see no reason why this doesn’t make it better at maintaining FDA standards, not worse.
Reason No. 2 to Sell WFM Stock
InvestorPlace contributor Jayson Derrick made a compelling case June 14 why not to own WFM stock. Much of his argument revolves around the idea that grocery competitors such as Costco Wholesale Corporation (COST) and The Kroger Co (KR) are stealing Whole Foods’ thunder by offering lower organic prices — essentially, he believes they are taking market share and Whole Foods doesn’t have an answer to stem the tide.
Silver Lining: Of course, Costco, Kroger and all the other grocery stores selling organics are going to toot their own horn at the exact moment that the biggest player in the industry is suffering deterioration in its business. There’s blood in the water.
But here’s the thing: Whole Foods doesn’t need to be Kroger in order to be successful. It just needs to be Whole Foods, but at slightly lower margins.
Whether it gets to an optimal price point through the rollout of its “365” stores or through price reductions at its regular format stores is immaterial. It just needs to adjust its business expense structure to meet the new reality, which is one in which people want better food at reasonable prices. There’s no reason it can’t get there. Investors might have to be patient but John Mackey and Walter Robb can get this done.
Reason # 3 to Sell Whole Foods Stock
Its same-store sales dropped 3% in the second quarter — its third consecutive quarterly decline — a full percentage point worse than analysts’ expectations with traffic accounting for 70% of the decline and the basket size the rest. Some analysts see the decline in basket size as troubling, given Whole Foods has been actively pushing prices lower.
One would think lower prices would result in the same or larger basket size. Macquarie Research said in May, “… basket mix may be trending in an unfavorable direction and could be difficult to correct.”
Silver Lining: As Whole Foods business has softened in the last year, future same-store sales growth becomes easier to achieve, and while setting the bar lower isn’t a recipe for long-term success, it should help slow the decline of its stock, which is down 8.8% year-to-date through June 17; that’s on top of 32.5% and 12.0% declines in 2015 and 2014, respectively. The bottom appears to be close.
As I mentioned previously, there’s blood in the water. Whole Foods’ competitors sense it, analysts sense it … heck, even investors sense it. You don’t lose 38% of your market cap over 36 months if things are going swimmingly. On an annualized basis, WFM stock has underperformed the S&P 500 by a full 25 percentage points. That’s downright painful.
Whole Foods: The Contrarian Play
However, it’s important to keep these three things in mind before selling WFM stock.
1. Does it make money? The answer to that is a resounding yes. In the trailing 12 months, it made 5.3 cents on every dollar of revenue. That compares to 3.3 cents for Kroger and 3.1 cents for Costco. Sure, the growth story is stalled, but business is first and foremost about profits.
2. How’s WFM’s valuation? It currently has a price-to-sales ratio of 0.7. That’s almost half its five-year average of 1.3. Meanwhile, Costco’s P/S is 0.6, 0.1 higher than its five-year average. Same thing for Kroger: Its P/S is 0.3, 0.1 higher than its five-year average. Whole Foods has gone from being obscenely overvalued to fairly or undervalued relative to its peers.
3. Can it cut costs? Absolutely it can. Barron’s pointed out this fact in early June reminding investors that Whole Foods’ selling, general and administrative expenses per square foot were more than double Kroger’s. Whole Foods definitely can play the price game.
The bottom line as I see it is that the naysayers are saying the same things about Whole Foods that were being said about McDonald’s Corporation (MCD) when it had same-store sales slumps in 2012 and again in 2015.
We all know how that turned out.
Whole Foods is going to be fine. Market leaders adapt, even if it’s painful.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
