Is Whole Foods Still A Natural?

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After the 9.4% fall in Whole Foods Market's stock Feb. 9, should investors expect shares of the natural- and organic-foods grocer to rebound any time soon? Don't count on it, some analysts say, though they note the stock is unlikely to head much further south.



Wall Street's euphoria over Whole Foods (WFMI), a retailer with an unusually rabid customer base, got ahead of itself, they argue, only to be pricked by a slightly weaker-than-expected quarterly earnings report.



Whole Foods' dominant market position will likely keep its stock from falling much further. That said, "You just can't justify a material upside from here based upon the business outlook vs. the price of the stock," says Jason Whitmer, an analyst at FTN Midwest Research Securities [see BW Online, 2/1/06, "Supermarket Stocks Look Appetizing"].



In the Feb. 9 trading, Whole Foods' stock fell $6.78 a share, to $65.27. Over the past year, shares of the Austin [Tex.]-based grocer traded as high as $79.90. The steep decline came after Whole Foods reported a 26% increase in fiscal first quarter earnings on a 22% increase in sales. Net for the quarter ended Jan. 15 rose to $58.3 million, or 40 cents a share, from $46.2 million, or 34 cents a share, for the same period a year ago.



SKY HIGH P-E. Revenue at the 180-store chain rose to $1.67 billion, up from $1.37 billion, driven in part by a hefty 13% increase in sales at stores open at least a year. But investors pounded the stock because earnings per share fell one cent below the consensus estimate, marking the second quarter in a row that Whole Foods has fallen short of Wall Street's forecast [see BW, 3/14/05



"What Could Take a Bite Out of Whole Foods"].



Even with the decline in share price, Whole Foods' stock is trading at one of the highest price-earnings multiples of any growth retailer, let alone any traditional supermarket chain. Before the decline, the stock was trading at 49 times forward earnings-per-share estimates. That compares to the low-to-mid teen multiple for traditional supermarket chains. And its forward PE exceeded such heady growers as Starbucks (SBUX).



Andrew Wolf, an analyst at BB&T Capital, says Whole Foods' 20% sales growth supports the higher multiple, but the retailer's deceleration in earnings over the past two quarters doesn't. For the first quarter, Whole Foods missed forecasts because of a decline in its gross profits as a percent of sales, which fell slightly to 34.49% from 34.56% a year ago. It blamed the margin decrease on seasonal factors.



CONTROLLING POSITION. During the fourth quarter of fiscal 2005, it missed the consensus estimate by 2 cents because of store-opening costs. Wolf now expects Whole Foods' earnings over this fiscal year to increase by 18%, down from a compounded annual growth rate of 22% over the last five years. The slower earnings growth, he figures, would support a multiple of 40 to 45 times forward earnings, just around where the stock is now. Whitmer agrees, saying, "All the positive expectations for the next three years are baked into the stock now."



If some analysts don't see much upside to Whole Foods' stock, they also don't see much downside from here. The retailer dominates the natural-foods market, with about 70 more stores than is closest rival, Colorado-based Wild Oats Markets (OATS), and has far larger stores [see BW Online, 3/17/05, "Prudential Upgrades Wild Oats" ]. Whole Foods currently has 72 new stores in development, where land and lease agreements have been finalized, says Wolf.



Surprisingly, Wolf adds, Whole Foods doesn't face a strong No. 2 like Home Depot (HD) does with Lowe's (LOW). "Until it has any real viable competitors, it should keep its multiple." That could mean returns will stay healthy.