Whole Foods Market, Inc.: No Investor Should Hold WFM

Whole Foods Market, Inc. (NASDAQ:WFM) is off about 5% today — part of a chain reaction stemming from a guidance cut by fellow organic grocer Sprouts Farmers Market Inc (NASDAQ:SFM).

Whole Foods WFM stock

You couldn’t ask for a more perfect example of what’s wrong with trying to hold Whole Foods stock anymore.

How Whole Foods Started to Crack

Whole Foods has had quite an interesting history. The organic grocer took a dual expansion approach. It opened de novo stores, and also rolled up small organic food stores like Mrs. Gooch’s and eventually ate up Wild Oats Markets. If you bought WFM stock at the initial public offering at $1.84 (split-adjusted) and held to its peak of $65, you did supremely well.

Whole Foods stock had long been a solid bet, and I really thought it might be a long-term core holding for my portfolio. WFM seemed to be the category killer in organic food.

But something unexpected happened.

It wasn’t the competition from the now-private The Fresh Market or Sprouts Farmers Market Inc (NASDAQ:SFM), but rather competition from established grocery store chains offering their own private-label organic food.

Even I wasn’t concerned at first. The people who shop at Wal-Mart Stores, Inc. (NYSE:WMT) are not the same demographic as those shopping at Whole Foods. However, there was overlap between WFM shoppers and those who went to regular grocery stores.

Loyalty apparently meant very little to Whole Foods customers. If they could get the same or similar items at their neighborhood grocery store, they clearly would abandon the organic trailblazer not only for convenience but for lower prices.

WFM earned the named “Whole Paycheck” for a reason.

WFM: One Mistake That I Hate

Whole Foods stock has been declining as same-store sales have been sagging. Free cash flow is still robust, although WFM has been spending more on capital expenditures to redesign stores. Cash on hand has also fallen from about $1.2 billion to $625 million. Worst of all, Whole Foods finally took on debt of about a billion dollars and for the worst possible reason: share repurchases.

I hate this.

To me, it was the first massive mistake that turned me off WFM stock. The only reason to take on debt is for low-cost expansion capital. Whole Foods doesn’t need working capital. It has plenty of free cash flow and cash on hand. The other other reason to use debt for share repurchases is if the stock is truly and seriously undervalued.

This is a sign that management ran out of ideas and is leaning on financial engineering. That’s a big red flag.

Another Troubling Development: 365

The other problem is the opening of Whole Foods’ new 365 stores. These are basically stripped-down versions of typical WFM stores with cheaper products, no cut-to-order deli or bakery, about a third of the selection, fewer employees and a rewards program.

You know what this reminds me of? Old Navy — the lower-cost version of the Gap Inc (NYSE:GPS) store. That was a great idea for a while, and then the Gap slowly became irrelevant thanks to cannibalization. GPS stock has appreciated 240% since Old Navy’s debut in March. The S&P 500 is up 370%.

I worry that 365 will cannibalize existing WFM stores, unless they are located sufficiently far away from those existing stores. If so, this may boost Whole Foods’ fortunes. It only has 434 stores, so dropping lower-cost competitors next to neighborhood grocery stores might just work out.

Bottom Line

Personally, I would not buy and hold Whole Foods stock anymore. I still would swing trade it, including right now, as it’s priced low enough for that.

The one-year chart is very telling. WFM stock swings between $29 and $35. We’re right at the bottom of this yearlong range. Buy in here, and look to exit between $33.50 and $35. Set a stop-loss at $27.75.

Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/09/whole-foods-market-inc-wfm-stock-no-hold/.

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