It didn't take long for panic to erupt among Whole Foods (NASDAQ:WFM) investors after Wal-Mart (NYSE:WMT) announced its arrival in the organic foods market by offering Wild Oats organic products at a 25% discount. As Americans developed healthier eating lifestyles and shifted towards organic and natural foods, Whole Foods, as with rivals like The Fresh Market (NASDAQ:TFM), has grown to prominence. But now Wal-Mart aims to grab a foothold in that market.
Wal-Mart said that in the coming months, it will introduce Wild Oats at roughly 2,000 stores, which is half of its national footprint. To the extent that Wild Oats is able to gain enough traction against Whole Foods, Wal-Mart will likely roll it out to the rest of the country, which makes sense. Wal-Mart management wants to ensure that there are no hiccups with things like supply and distribution.
Recall, this is the same strategy used by Whole Foods when Whole Foods attempted to buy out the Wild Oats chain of stores in 2007. The FTC protested the acquisition under antitrust law, and in 2009 Whole Foods sold Wild Oats under court order. Wal-Mart is looking to revive the brand, presumably to attack Whole Foods. But will it work?
Since Wal-Mart's announcement, shares of Whole Foods are down roughly 10%. This news has also impacted Sprouts Farmers Market (NASDAQ:SFM), which has also taken a punishment. The market has suddenly appeared skittish about this new threat. And Whole Foods management, which will report fiscal second-quarter earnings Tuesday, has a touch job ahead of them to convince investors that there will be no hiccups in operation.
The Street will be looking for an 8% year over year jump in earnings per share to 38 cents. Last year, Whole Foods reported 38 cents. In terms of revenue, analysts will be looking for $3.34 billion, which would represent 10% year-over-year growth, topping last year's mark of $3.03 billion.
Recall, in Whole Foods' February quarter, the company also posted a 10% jump in revenue to a record $4.2 billion. This is while profits grew more than 8% year over year to $158 million. What bothered investors was the noticeable deceleration in same-store-sales growth, which arrived at 5.4%, down 2 points year over year. And this is with weakness being seen in the older stores.
By contrast, stores that had been opened for at least one year (but less than two) were up close to 20%. But as with any new location, you can expect this to continue. Aside from the new threat from Wal-Mart, Whole Foods has been threatened by other competitors, including Kroger (NYSE:KR), which has also added to its natural and organic foods category.
On Tuesday management has to convince the Street that these results are not the beginning of a sustaining trend. Even more important, the company has to guide in a manner that alleviates fears about saturation, which some experts believe has already impacted areas like San Francisco and Boston. These are cities in which Whole Foods has 20 stores each.
And now that Wal-Mart has entered, this adds another layer of concern regarding margin pressure and long-term profitability. From my vantage point, I can't recommend these shares until management shows that it can re-accelerate same-store sales growth, while at the same time, implement strategies to prevent Wal-Mart from stealing away its market share.
Making matters worse, these shares are still not cheap, even with the recent double-digit decline. The stock is trading at a P/E of 33, which is half the valuation of Wal-Mart. This means the Street is still expecting double-digit long-term revenue growth, which doesn't seem like it will hold for the next several quarters. At $49 per share, I project at least 10% downside to around $44 on the basis of continued deceleration of comp growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Wall Street Playbook's retail sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.