Is Whole Foods Market Disappointing Investors?

Mar.13.14 | About: Whole Foods (WFM)

Summary

Successive disappointing quarterly results have hurt Whole Foods Market’s share price.

The industry potential is huge. So, investors should ignore the short-term weakness and buy Whole Foods Market on the dip.

The recent additions of high-grade products and the opening of new stores should benefit Whole Foods going forward.

Whole Foods Market (NASDAQ:WFM), the leading grocer of natural and organic foods, has fallen upon tough times. The company has reduced its full-year comp sales forecast for 2014 to 5.5%-6.2%, compared with expectations for a 6.2% growth earlier. This is also below Whole Foods' own outlook for 5.5%-7% growth earlier. Moreover, the company's recent first-quarter results were not great as it missed on earnings, despite reporting good revenue growth.

Recap of results

In Q1, Whole Foods' sales increased 10% from last year to a record $4.2 billion. The company reported 13.3% return on invested capital and generated $337 million of operating cash flow. However, the company's business saw a gradual decline in the quarter after comps increased 5.8% for the first five weeks, but dropped to 5.2% for the last 11 weeks.

Revenue dipped due to a weak macro environment. Also, a severe winter across the U.S. negatively impacted shopping patterns, as customers made fewer trips to Whole Foods stores. The company's shares have slid 7% so far this year, and the subdued prospects would make the going difficult going forward.

Improvements ahead

But, Whole Foods is focusing on improving its price competitiveness. The company is adding more high-grade conventional products to its stores in an effort to complement its organic offerings. This would give customers a broader range of choices to buy at Whole Foods Market. In the meat segment, Whole Foods has rolled out fresh packaged chicken under the 365 Everyday Value brand to all its stores in the U.S. This brand is well recognized for value and quality by customers, and tends to be the best seller in most grocery categories.

Looking ahead, Whole Foods is bullish about its growth as the company continues to accelerate new store openings. With 10 new stores opened last quarter, along with new products such as coffee, beer, and wine bars to highly popular cold pressed raw juices and oyster venues, Whole Foods can expect better times going forward.

Also, Whole Foods' new stores have been performing very well. Comp sales at stores less than two years old have produced an average 16% return on invested capital, which is its best new store metric. Moreover, the updated outlook for fiscal year 2014 is conservative, according to Whole Foods, as the company is making investments to grow its business and this could pressurize margins in the short-term.

The company is increasing spending on technology, and also improving upon the customer experience through a unified ecommerce platform. Whole Foods announced a partnership with Square, enabling it to offer digital check-out at venues and select stores. In addition, it is also focusing on testing out other exciting innovations as well, along with acquisitions. Recently, Whole Foods announced the acquisition of seven former Dominick's locations, which will allow it to quickly and significantly expand its presence in the greater Chicago area.

Industry's potential

The company is very confident regarding its growth potential going forward, and is moving aggressively to take advantage of this opportunity since the industry is expected to grow at a CAGR of 14% till 2018 in the U.S.

Globally, the organic industry is expected to be worth $ 187.85 billion by 2019, according to Transparency Market Research. To make the most of this opportunity, Whole Foods has signed 57 new leases in the last 12 months, putting 107 stores in its development pipeline. Also, Whole Foods is targeting 1,200 stores in the U.S. alone in the future, which is a good move since the U.S. is the largest market for organic food globally.

So, Whole Foods is moving in the correct direction despite short-term weakness. Since the industry is expected to grow at strong rates going forward, it is quite natural for Whole Foods to make investments in order to stay ahead of competitors. The likes of Wal-Mart (NYSE:WMT) and Kroger (NYSE:KR) have also started stocking organic food items on their shelves, which makes Whole Foods' presence of less than 400 stores a big disadvantage. These bigger players have a wide store footprint in the U.S., so Whole Foods will need to differentiate its products if it is to continue thriving going forward.

Valuation and conclusion

Some might call Whole Foods Market expensive at a P/E ratio of 36. However, the industry's prospects and analysts' projections going forward are quite optimistic, justifying its premium valuation. As we saw above, the industry is expected to grow at a good pace going forward, while analysts expect Whole Foods' earnings to increase at a CAGR of 17% over the next five years. Thus, investors should treat Whole Foods Market as a good investment for the long run as its growth story isn't over yet.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.