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Summary

  • Increasing competition is forcing Whole Foods to adopt reactive measures, which will pressurize its margins going forward.
  • Whole Foods is expensive relative to its growth.
  • Whole Foods is undertaking some impressive measures, but a weak outlook and cheaper offerings from established grocery stores will hurt its performance.

It couldn't have been worse for Whole Foods Market (NASDAQ:WFM) this year. Shares of the organic food company have taken a massive beating, declining around 35% so far in 2014. Whole Foods is facing intense competition from several angles in the organic food industry, and the company's disappointing second-quarter results indicate that there is no respite going forward.

The stock has been pushed down to its 52-week low, and there seems to be no turnaround in sight. So, should investors dump Whole Foods? Let's find out.

Weak performance

Although Whole Foods' sales in the first quarter increased 10% year over year to $3.3 billion, its earnings were flat. Considering that Whole Foods trades at an expensive P/E ratio of 25, a flat earnings performance is disappointing. In addition, management's outlook was also concerning.

Whole Foods was once a leader in natural and organic foods, as a result of which investors valued it more than its peers. However, the company's growth attracted attention from rivals, and made Whole Foods vulnerable to competition.

The competition is intensifying

Now, many mainstream retailers such as Kroger (NYSE:KR), Safeway (NYSE:SWY), The Fresh Market (NASDAQ:TFM), and Wal-Mart (NYSE:WMT) have entered this segment. Wal-Mart, for instance, recently entered into a deal with Wild Oats to sell organic food products at lower prices. According to Forbes:

The world's largest retailer Wal-Mart recently partnered with Wild Oats brand to sell organic foods at non-organic prices. The company will be offering a range of pantry staples from Wild Oats priced at least 25% cheaper than other national organic brands and in line with conventional food items. This deal can help Wal-Mart take advantage of soaring demand for organic products in the U.S. as well as revive its stumbling grocery business. The retailer will be launching 100 Wild Oats products ranging from salsa to pasta in 2,000 of its stores in the next few months and will add the brand to its remaining stores at a later stage.

Store expansion and technology to counter the threats

Hence, the competition in the organic foods market has increased, and Whole Foods is being forced to take necessary steps to stay ahead of peers. Whole Foods is expanding into low-income neighborhoods, smaller cities, and suburbs. Keeping this in mind, it recently opened stores in Detroit and West Des Moines, Iowa, and plans to open one in Chicago's South side next year. Earlier, Whole Foods was focused on providing its products to the high-income category, and its move lower down the income chain will force it to cut pricing, creating pressure on the margins in the process.

Whole Foods expansion plans do not stop here. Since the first quarter, it has added eight stores in six new markets. It is of the opinion that its EVA-based approach to site selection will enable it to succeed in diverse markets such as Jackson, Mississippi, San Luis Obispo, California. Now, these expansion moves will need capital investments, and again pressurize Whole Foods' earnings going forward.

However, Whole Foods is making some positive moves on the supply side. It is developing its supplier network through exclusive partnership programs. To further strengthen its relationship with its suppliers, Whole Foods is offering them loans. Till date, it has provided more than $12 million in loans and has built a network of 176 unique suppliers.

Going forward, management is optimistic about its prospects. In addition, Whole Foods is projecting itself as more than just a grocery store. According to management, "We are a restaurant and premier brand with sales of $2.5 billion in prepared foods and bakery, and $1.7 billion in exclusive brands in the last year."

Additionally, the company is improving its customer experience by investing in technology, which will enable them to connect with its customers either physically or digitally, or may be both. It has several pilot projects under its sleeve, which includes click and collect, direct delivery, payment at food venues using square, a mobile app, affinity program, and expanded access to its e-store. The company anticipates that it will gain share as the demand for fresh, healthy food rises.

Not so impressive

Clearly, management remains optimistic about Whole Foods' prospects. However, it cannot be denied that the company is facing stiff competition in the market. At the same time, its valuation isn't enticing. As stated earlier, Whole Foods trades at 25 times last year's earnings, which is quite high considering that its earnings are expected to grow at a CAGR of 13.5% over the next five years, below the industry average. It also has a PEG ratio of 1.86, which further indicates that the stock is overvalued. As such, it would be a good idea for investors to stay away from Whole Foods, and if they hold it in their portfolio, they should consider selling the stock.

Source: Stay Away From Whole Foods Market