3 Reasons Why Whole Foods Market, Inc. (WFM) Stock Is a Contrarian’s Dream

According to the 25 analysts covering Whole Foods Market, Inc. (NASDAQ:WFM), WFM stock is a hold; just five of them consider its stock a buy, unchanged from three months ago. What has changed is the number of underweight or sell ratings, increasing from six to seven over the past 90 days.

3 Reasons Why Whole Foods Market, Inc. (WFM) Is a Contrarian’s Dream Stock

Most experts don’t like Whole Foods stock and it certainly wasn’t helped in early December when Kroger Co (NYSE:KR) lowered its outlook on its 2016 earnings, the second time this fiscal year.

Deflation has been wreaking havoc at all grocery stores, big and small, profitable and unprofitable, and given that Whole Foods is in the middle of a major turnaround, it’s understandable why it might seem like the entire investment community has suddenly got a hate-on for the former grocery store phenom.

That’s the fickle nature of stock markets talking — loud and clear.

Which brings to mind the old Warren Buffett quote, “Be greedy when others are fearful.”

Well, I searched high and low for positive comments about Whole Foods and one of the only ones I could come up with are from Oppenheimer analysts Rupesh Parikh and Erica Eiler who recently called it their top grocery pick for 2017.

Kroger investors: Put that in your pipe and smoke it!

But seriously, Whole Foods is looking like a contrarian’s dream stock for these three reasons; with a little luck and a lot of hard work, WFM could turn out to be a shining star in 2017.

WFM Stock’s Valuation

David Dreman is a pioneer in contrarian investment strategies and behavioral finance. I own his 1998 book, Contrarian Investment Strategies: The Next Generation. The book lays out quantitative methods he uses for screening for contrarian stocks.

To make the cut, a stock must have a market cap greater than $1 billion, a current ratio (current assets divided by current liabilities) greater than 2, debt-to-equity less than 50% and a P/E, P/B, and P/FCF that’s lower on relative basis to its peers.

On the first three criteria, WFM doesn’t quite make the cut but comes pretty darn close.

  • Market cap = $9.7 billion (pass)
  • Current ratio = 1.47 (fail)
  • Debt/equity = 32.6% (pass)

It’s important to mention that Whole Foods issued $1 billion in 5.2% senior notes during fiscal 2016 that don’t mature until 2025. Prior to 2016, it carried virtually no debt. While I’m normally not a big fan of stock buybacks, WFM’s decision to use some of these proceeds for repurchases makes sense given how its stock appears undervalued.

On the three price criteria, I’ll compare WFM to Kroger.

  • P/E: WFM = 19.9, KR = 16.1
  • P/B: WFM = 3.0, KR = 4.7
  • P/FCF: WFM = 12.2, KR = 21.2

On the price criteria, WFM stock is a much better value than Kroger in my opinion, despite having a higher P/E. That’s because WFM’s P/E is much lower today than in the past.

On the current ratio fail, it’s important to note that Kroger’s is 0.74. So, on a relative basis, I see that as a pass.

Potential Buyout Limits Downside

Following on the valuation section from above, Whole Foods has become a potential target for both private equity and strategic acquirers such as Kroger, who InvestorPlace.com contributor Tom Taulli recently reminded us is in need of acquisitions to fuel the growth monster.

I’m not so sure that Kroger is the best fit given how much effort they’ve put into their own natural and organic foods offerings which account for more than $11 billion on an annual basis or more than 10% of its overall revenue.

Furthermore, when a $40 Kroger buyout rumor hit the street in October 2016, it was quickly extinguished, John Kilhefner, InvestorPlace.com Assistant Editor, wrote at the time. However, since then, WFM stock has drifted up and down between $30-$32, never heading lower … suggesting where there’s smoke, there’s fire.

Jerome Dodson Likes WFM Stock

“Who?” I can hear you saying.

Dodson is the founder of Parnassus Investments, one of this country’s earliest socially responsible investors; his $1.8 billion Parnassus Endeavour Fund (MUTF:PARWX) also delivered market-beating returns, up 20.2% on an annualized basis over the past five years.

Dodson talked to Barron’s in early December about five unloved large-cap stocks, and one of them just happened to be WFM. Dodson doesn’t see huge gains on its stock over the next three years, but he does believe it can hit $50, 65% higher than where it currently trades.

How will it get to $50?

By continuing to focus on providing better value to customers through lower prices and to a lesser extent on its smaller 365 by Whole Foods Market stores … although reading Phil Lempert’s June 2016 review of a new store opening in Forbes, WFM might just want to stick to lowering prices and keeping costs under control because he was totally unimpressed.

Time will clearly tell about 365 but I’m of the mind that’s it’s still very early in the process and investors need to give CEO John Mackey more time.

So, if you’re a value investor, WFM stock must be on your shopping list because the odds of it being bought out are probably 50/50 in 2017 and higher than that in 2018 and beyond.

As an added bonus, its dividend yield of 1.8% is higher than Kroger.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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