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Summary

  • Intensified price competition will hurt gross margins and earnings growth.
  • Comparable store sales are expected to slow again.
  • Even with ambitious 2018 targets, shares are not obviously cheap yet.

Investors in Whole Foods Market (NASDAQ:WFM) are shocked after the natural and organic food retailer lowered its estimates for the third time this year while issuing a long-term growth roadmap towards 2018.

While operational and share price momentum remains negative, I would be willing to pick up shares in a $30-$35 region reflecting an acceptable valuation for a long-term growth story.

Second-Quarter Headlines

Whole Foods Market reported second-quarter revenues of $3.32 billion which is up 9.7% compared to last year. Topline growth was driven by new store openings and a 4.5% increase in comparable store sales which saw a 50 basis point negative impact from the shift of the Easter holiday.

Comparable store sales growth was driven by an equal increase in the number of transactions and average transaction size. Comparable sales growth slowed down a lot from reported comparable store sales growth of 6.9% in the second quarter of last year.

While topline growth was already soft there was quite some pressure on margins. For starters, gross margins fell by 0.6% to 35.85%. These margin pressures combined with increasing selling, general and administrative expenses resulted in flat net earnings at $142 million.

As a result GAAP earnings came in unchanged at $0.38 per share.

Lowered 2014 Outlook

As a matter of fact, comparable store sales trends keep causing worries. For the six weeks ending on May 4, same store sales slowed down to 4.3%.

On the back of the disappointing developments, Whole Foods is negatively adjusting its full year outlook. Sales are expected to increase between 10.5% and 11% on the back of comparable store sales growth of 5.0% to 5.5%. Previously, Whole Foods guided for 11.0% to 12.0% sales growth on comparable store sales growth of 5.5% to 6.2%.

This should translate into earnings of $1.52 to $1.56 per share. This compares to a previous outlook for earnings between $1.58 and $1.65 per share.

Strategic Vision 2018

At the same time Whole Foods announced its long-term intentions. By 2018 it expects to have more than 575 stores, up from a current 379 store count. This comes as the company already has 114 stores in the current pipeline.

These stores should generate sales of $25 billion per annum, or $43 million per average store. This compares to sales expected just north of $14 billion this year, which implies average sales of about $39 million per store. For the very long term, Whole Foods sees market potential for 1,200 stores within the US.

Whole Foods aims to deliver earnings per share growth which is equal or exceeds sales growth of an expected 13% per annum between 2015 and 2018. Comparable store sales are seen at 6% for the period 2015-2018 while the remainder of growth comes from store openings.

Gross margins are seen at the historical 34-35% range, which is actually down from the 35.8% reported in the second quarter.

Based on the company's forecast earnings are seen at $2.65 per share in 2018, resulting in earnings of about a billion per annum.

Valuation

Whole Foods has a rock solid balance sheet with access to nearly $1.1 billion in cash and equivalents while it has no outstanding debt. The company has $585 million in capital lease and regular lease obligations.

Based on the current outlook annual sales are seen at around $14.3 billion while earnings could come in around $575 million. Even after a 20% sell-off with shares trading at $38.50, the market still values equity in Whole Foods at roughly $14.3 billion.

As such net operating assets are valued at $13.2 billion, the equivalent of 0.9 times annual revenues and 23 times annual earnings.

The company returns modest amounts of cash to its shareholder through a $0.12 quarterly dividend which provides investors with a 1.2% dividend yield. This is being accompanied by a modest pace of share repurchases which came in at $55 million over the past quarter.

Implications For Investors

Whole Foods appears to have fallen out of favor with the investment community. Leading upto 2005 shares steadily rose to levels of $40 before falling to lows of $5 in the subsequent recession.

The very strong momentum in recent years has pushed shares to highs of $65 last year after which shares have lost some 40%. This came after the company lowered its full-year targets three times in a row.

Intensified competition for premium, healthy and sustainable foods from other food retailers like Kroger (NYSE:KR) among many others is kicking in. In a response Whole Foods has lowered prices which hurts margins and has a short-term negative effect on comparable store sales.

It seems that sentiment has changed in a dramatic way for Whole Foods and momentum remains towards the downside. That being said, the outlaid growth path towards 2018 should give investors enough confidence to pick up shares in a $30-$35 price region if they get the chance, buying into a long-term growth story at a fair valuation.

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.

Source: Whole Foods Market - Investors Capitulate After Lowering Guidance 3 Times In A Row