Whole Foods Remains A Sell Until $32

| About: Whole Foods (WFM)


Whole Foods was trading 4% lower after-hours after reporting yet another weak quarter.

Growth continues to decelerate, especially at older stores, forcing management to cut guidance once again.

With slowing growth and weak execution, shares are too expensive at 26x earnings and investors should wait until $30-$32.

Shares of Whole Foods Market (NASDAQ:WFM) dropped 4% after the bell on Wednesday as investors digested disappointing quarterly results. This is the fourth consecutive quarter that Whole Foods has reported weaker-than-anticipated results, which is the main reason why shares are down 30% over the past twelve months. Given the general move towards organic and healthy foods throughout the country, Whole Foods has been seen as a growth company with great potential, but the company has struggled to execute amid rising competition. The organic market space has become more competitive with entrants like Sprouts Farmers Market (NASDAQ:SFM), The Fresh Market (NASDAQ:TFM) and Fairway (NASDAQ:FWM) adding stores while legacy grocers like Kroger (NYSE:KR) and Safeway (NYSE:SWY) add organic offerings. Three months ago when shares were above $45, I recommended selling WFM and suggested buying it back around $38. After this quarter, I am lowing that entry to point to $30-$32. WFM is still a sell here after yet another disappointment.

In the quarter, WFM earned $0.41 compared to an estimate of $0.39 though a larger-than-expected buyback of $361 million was a major driver of this beat (financial and operating data available here). After all, revenue of $3.38 billion was about $20 million light. Same-store sales continue to decelerate and came in at a paltry 3.9%. This number is even worse when factoring in the fact Easter fell in the quarter. Excluding a beneficial calendar, comps were up only 3.3%. That growth suggests that Whole Foods is quickly becoming a mature company with slowing revenue growth. Transactions were up an even slower 2% with higher prices accounting for the other 1.9% of gains.

As has been the trend, older stores are the major laggards. New stores are still expanding their customer base, which leads to faster growth. Stores less than two years old grew 15.8%. However, that growth rates drops dramatically to 7.6% when a store is 2-5 years old. This suggests that Whole Foods saturates its market relatively quickly. From then on, growth continues to slow with 8-11 year old stores growing a meager 0.9%. After several years, Whole Foods matures and is struggling to bring new shoppers to its stores. With 388 stores, Whole Foods is quickly moving towards saturation, which will lead to continued deceleration. Whole Foods' growth ceiling is much lower than previously thought.

As a consequence, management was forced to cut guidance yet again. Sales will grow 9.6-9.9% compared to previous guidance of 10.5-11%. Comps will be 4.1-4.4% for the year, suggesting the fourth quarter will show growth below 3.5%. Operating margins also ticked lower to 6.4-6.5%, and higher competition continues to pressure gross margins. EPS growth this year is a meager 3-4%. The hard truth is that Whole Foods just isn't much of a growth company. In an effort to boost the share price against this negative outlook, WFM has launched a $1 billion buyback. With no debt, Whole Foods has the balance sheet to buy back stock, but with shares trading 26x earnings, buying back stock makes little sense as the price is too high. Paying too much for an asset, even one's own stock, is not a good thing.

With sales at its stores continuing to decelerate, Whole Foods is trying to branch out by launching a mobile app and offering home delivery, though it is obviously unclear whether this strategy will work. Home delivery is likely to have minimal impact as Whole Foods' atmosphere is part of its appeal. It is more akin to shopping at a natural market with varying stations and friendly service rather than going to a utilitarian factory-like supermarket. Whole Foods is struggling to gain further share because prices are expensive and the organic space is getting increasingly crowded every day. Kroger is happy with lower margins, and even food producers like Kraft (KRFT) are moving organic. These offerings don't solve those core problems.

At the end of the day, Whole Foods is a company with slowing growth that has continually failed to execute. 26x is too rich for a company that is a perennial disappointment and whose growth runway is coming to a close. Now, there is certainly a chance that WFM can restart its growth engine or that new initiatives will work better than I expect. While a company with WFM's recent track record and growth rate would merit a 15x multiple, I am willing to give WFM a bit of a premium given the longer-term trend towards organic food. I would consider getting long WFM at around 20x earnings or $30-$32. Still after this quarter, I would be a seller, but if shares do sell off towards $32, there is an opportunity to get long shares. With many growth companies performing well, there is no need to own WFM here. I continue to recommend selling WFM.

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.