Whole Foods Market: Recession Puts a Damper on Growth Strategy

Whole Foods Market, Inc. (WFMI) began 2009 trading at $9.44/share. At $24.20, the stock has climbed more than 160% in the first seven months of the year. With any gain as large as this, an important question is whether the gain is justified or the result of overly optimistic investors trading on their own momentum.

At its current stock price, the company’s Required Business Performance implies revenue growth of at least 5.2% in the upcoming twelve months and even higher levels of growth beyond that time. (See WFMI’s RBP Snapshot) While this may seem attainable given the company’s historical growth rates, with current market conditions it is relatively unlikely that the company will meet this Required Business Performance.

A quick glance at the company’s recent income statements may make the stock look very desirable. Revenue growth in most recent five fiscal years has averaged 15.8%. But giving heavier weighting to the company’s most recent experiences paints a different picture. The company’s RBP Probability is merely 48.8%, lower than all but two of its sector peers.

The company has traded at high levels for many years as a result of this record of growth as well as a belief on the part of investors of a secular trend towards organic and natural foods, a market niche in which Whole Foods is the leader. However, as the economy soured and Whole Foods customers traded down to cheaper, non-organic foods, sales growth stalled and investors began to see the limitations to the company’s growth strategy.

When the stock began the year at $9.44/share it was likely a bargain. Indeed, its RBP Probability was just over 68%. But as the price has skyrocketed in recent months Whole Foods’ RBP Probability has plummeted. Meanwhile, revenue grew only 1% in the twelve months ended April 13, 2009 as compared to the same period a year earlier, and operating income fell 7%.

Most of this decline is the result of poor same-store sales, which have continued to decline as the economy has remained sluggish. For the first half of the current fiscal year comps were down just under 5%. Thus, to attain revenue growth of 5.2% in the next year will require the company to open at least 15 new stores. No such plans are currently under consideration. The company currently plans to open only four new stores while relocating three more in the second half of the current fiscal year. This led management to estimate current fiscal year sales of $8 billion, significantly less than the $8.3 billion implied by the company’s Required Business Performance.

Whole Foods Markets my indeed be a good long-term investment. However in the current market and economic environment, better deals can be found. At this point it is probably best to look elsewhere in the Food Retailers & Wholesalers subsector, for companies with stock prices that are not dependent up on such substantial growth.