Here is my quick take on Whole Foods.
Price Oct 10($)
Price Today ($)
S&P 500 (SPY)
Whole Foods (WFM)
Undeniably Relatively Unattractive
As you can see Whole Foods' shares have underperformed pretty much anything you can think of as far comparables go since I last wrote about it. This has little to do with failed execution, and everything to do with the stock just being poorly priced. While I don't bother comparing Whole Foods to the other grocers when I try to get at a reasonable value for the stock, you can clearly see that buying the "unsexy bunch" in grocery land was the way to go over the past four months (as is often the case in the market, the losers became winners and the big winner became the loser). At some point this will flip again, but as far as I am concerned, we are nowhere near that point yet. Even after the after-hours mini sell-off ,Whole Foods still looks like a negative value proposition to me. The shares still trade at a premium multiple to my two favorite comparables; Chipotle and Starbucks, both of which are forecast to grow earnings 17% and 16% this year versus 13% for Whole Foods. This is a bad combination, especially when you consider the fact that Chipotle and Starbucks sport operating margins that are 2-3x Whole Foods. Also, Wal-Mart is getting more aggressive on the organic front, and several traditional competitors are showing signs of metric stabilization. Overall, it doesn't matter whether or not you view it as a premium food retail brand or just an excellent grocer, there is no relative value case to be made for Whole Foods right now.
So what's it worth?
I'd argue 20x forward earnings is fair assuming Whole Foods does better in the back half of the year and works its way up to a mid to high teens EPS growth rate. I'd then tack on a nice premium to that for their position in the market and execution track record. That gets you to 25x forward earnings or roughly $71 a share, and if everything is going amazing, I'd even be willing to go up to 30x or $85 share. Split the difference between these two prices, and you get $78. That's my fair value for the stock. Which basically means the name has to be plus or minus 10% from that price to make it worth buying or shorting. Last quarter, it took a small hit on earnings and then steadily rebounded with the market as I presume most traders were looking for Whole Foods to raise annual guidance on the Q1 report as they have typically done over the past few years. That didn't happen. Instead you got pretty good evidence that this will be a somewhat 'transitory' year as far as earnings growth goes, and that annual guidance, which over the past few years has been very conservative, will actually prove to be much more accurate. You could even argue that the tone on the call also leaves the door open for some downside surprises if the macro environment doesn't fully cooperate. Put these two things together and the last thing you want to be doing is overpaying today.
How to trade it?
Whole Foods is a market darling, which means more than a 5% drop reaction to anything short of a disaster quarter would normally surprise me. However, I think the tone of the conference call last night combined with its current nose bleed valuation relative to peers leaves it vulnerable to a more serious and swift decline. My guess is that momentum hedge funds run from the name as they conclude the next quarter or two won't offer the instant headline bang Whole Foods has been providing for the past few years. This should be the main driver of price until the stock completes a 20% correction. At which point, you might see some reallocating back into the name from the more patient money and value conscious growth types. So, basically you want to be short the stock until the low 80's which means anything over $90 is a gift for those looking for short trade exposure in their portfolio. Not exactly my favorite type of short, but definitely an ideal one for those looking for some stress free balance in this bullish tape.
Additional disclosure: via put options