Why Whole Foods Is A Sell Going Into Earnings

| About: Whole Foods (WFM)

Summary

Whole Foods disappointed earnings last time, and it looks like the trend will continue.

Whole Foods might need to slash prices, as the company was recently accused of overcharging.

Competitors also are taking advantage of Whole Foods' premium pricing by introducing lower priced products.

Whole Foods' earnings are expected to grow at a slower pace over the next five years than the last five, indicating weakness.

Whole Foods Market (NASDAQ:WFM) is in a soup this year. It has taken a heavy beating on the stock market, with shares down 35%. The company will look to get back on track when it reports its third-quarter earnings on July 30. But, will Whole Foods be able to start its turnaround with the upcoming earnings report? Let's find out.

The expectations

For the third quarter, Whole Foods' top line is expected to jump almost 11% year-over-year, while earnings are expected to go up just a penny to $0.39 per share. Considering that Whole Foods trades at an expensive trailing P/E of 25, and is expected to benefit from the fast-growing organic foods market, its expected performance is not up to the mark.

The company has a mixed past of satisfying earnings estimates. In the last two quarters, Whole Foods has missed bottom line estimates. Moreover, it had slashed its outlook the last time it reported earnings, so the future looks grim. The value strategy of Whole Foods Market is affecting its sales growth and gross margin.

The company needs to cut its pricing in order to remain competitive with the likes of Wal-Mart (NYSE:WMT), which are entering aggressively into the organic food space with lower-priced products. As a result, a turnaround at Whole Foods might not be possible in the near term until and unless the company makes solid improvements.

Facing trouble

Whole Foods is trying to make some improvements to the business. It is focusing on widening its customer base. Importantly, its ongoing efforts are targeted to further differentiate its product offering and advance its leadership in areas that are crucial to its loyal customers.

Customers expect Whole Foods Market to create and curate new and existing products. According to management, the offerings of Whole Foods Market are unique and available only with it. However, it seems to be losing this advantage, as customers are focusing on lower-priced products. Wal-Mart is trying to tap this trend and eat into Whole Foods' market share. The company has entered into a deal with Wild Oats to remove the premium from organic food. 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."

A landmark judgment

Moreover, it looks like Whole Foods' premium pricing won't stay for long. The company will eventually have to cut its pricing, which is evident from the fact that it was recently fined for overcharging customers in California. As reported on CNBC:

"Whole Foods Markets has agreed to pay $800,000 after an investigation found that the supermarket chain overcharged customers in California, officials in the state said on Tuesday.

State and local inspectors found during a year-long investigation that Whole Foods charged more than the advertised price on many items, according to a statement from Los Angeles City Attorney Mike Feuer.

Problems included failing to subtract at checkout the weight of salad bar containers, giving less weight than shown on labels for packaged items sold by the pound and selling items such as kebabs and deli foods by the piece rather than by the pound as required by law.

Whole Foods agreed to pay $630,000 in civil penalties to the city attorneys of Los Angeles, San Diego and Santa Monica, who brought the case. It will also pay $100,000 into a consumer protection trust fund, and $68,394 for costs.

The Austin, Texas-based company also agreed to a five-year injunction that requires accurate pricing, increased monitoring of its pricing practices and random audits."

If other regions around the U.S. follow suit, then Whole Foods will need to price its products properly to avoid such fines.

Investments to take a toll

At the same time, Whole Foods is investing aggressively to grow the business, and this will again take a toll on its earnings performance going forward.

The company is developing exclusive partnerships through efforts such as the local producer loan program, through which it has disbursed more than $12 million in loans, building relationships with 176 unique suppliers. Whole Foods also is investing $143 million in new and existing stores. It recently launched eight stores in six new markets.

The retailer also is aggressively investing in technology. Whole Foods Market has various pilot projects in progress, including click and collect, direct delivery, payment at food venues using Square, a mobile app, an affinity program, and increased access to its e-store around the year. It plans on creating unified and unique experiences to add choices, convenience, and flexibility in customer's busy lifestyles.

Conclusion

Whole Foods might not come out of its slump anytime soon. The company is struggling in the face of stiff competition, and due to investments that it is making in the business, its earnings growth might slow down further. In fact, over the next five years, Whole Foods' earnings are expected to grow at a rate of just 13.5% a year, way behind the growth of 30% a year seen in the last five. So, investors should stay away from Whole Foods going into earnings, as it is far from a turnaround.

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