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Summary

  • Whole Foods Market has been performing exceptionally well due to the improving market situation and rising demand for organic food.
  • The demand for organic food is projected to continue rising in coming years.
  • The company’s balance sheet is as healthy as the products available in its stores, as depicted by the liquidity ratios and debt profile.
  • However, the company’s stock is highly overpriced based on the price multiples.

Since the start of the economic turmoil in 2007, U.S. consumers have been spending their money grudgingly and seeking lower-cost products. The opposite is true in the case of the organic food market due to the rising concerns over high processing and artificial ingredients in foods.

Organic food sales in the U.S. now comprise nearly half of global organic food sales. The trend has really helped Whole Foods Market (NASDAQ:WFM), the largest U.S. chain of natural and organic products, to pick up growth.

Revenue Drivers

Whole Foods' top line growth depends on its ability to increase sales in its identical stores and open new stores. In the first three quarters of FY14, it opened 27 new stores and acquired 3 stores which provided the company an even stronger foothold in the industry. More than half of the new stores were opened in new markets in order to seek additional opportunities.

In the third quarter of FY14, the company's sales totaled around $3.377 billion reflecting an increase of 10.43% throughout the third quarter of the previous year. Besides the newly opened and acquired stores, the drivers for this revenue growth were an increase in comparable and identical store sales. Comparable store sales increased 3.9% while identical store sales increased 3.5%. After making adjustments for the Easter shift, the comparable store sales increased 3.30% and identical store sales increased 2.90%.

Source: Financial Press Releases

As the financial conditions in US improve and the consumer confidence index has jumped to the highest level since 2007 thanks to better employment conditions and robust equity markets, I expect Whole Foods Market to continue achieving considerable growth in its top line. Moreover, more and more consumers are turning to natural and organic food due to advice from health associates. The younger and high income demographics are the proponents of this trend. The forecast is a CAGR of 14% on the U.S. organic food sector from 2013 to 2018.

Earnings Driver

Net earnings in this quarter jumped more than 6% compared to the earnings figure reported 3Q2013. The positive revenue growth is not the only reason behind the company's earnings growth as cost-cutting strategies have also contributed. Both the direct store expenses and the general and administrative expenses as a percentage of sales decreased in the third quarter reflecting leverage in healthcare costs and wages. However, the company's cost of goods sold increased slightly as a percentage of sales, offsetting the positive effects of the decline in operating expenses and putting downward pressure on EBITDA and net margins.

The company's management expects the margins to remain slightly depressed in the fourth quarter and full fiscal year 2014 compared to the figures reported in fiscal year 2013.

Balance Sheet

The company's current and quick ratios deteriorated slightly in the first nine months of 2014 compared to the figure reported during the same period last year. However, the company still has a very strong liquidity position as both the ratios are greater than 1. This gives the impression that the company can easily meet its short-term financial obligations and can overcome any unexpected operational disruption. The quick ratio shows that even if the inventory, a major part of its current assets and more illiquid than the other current assets, becomes obsolete or loses its value, the company would still be able to meet its obligations by converting its other current assets.

Whole Foods' debt increased in the first three quarters of this fiscal year but the amount of debt is still very negligible compared to its earnings and cash flows. At the end of the third quarter of 2014 the company had a total debt of only $62 million while its net earnings and cash flows in the first three quarters were $451 million and $859 million, respectively. So, the debt can easily be paid through its cash flows.

The increase in debt in fiscal year 2014 has actually benefited the company's equity holders as the return on equity has improved during the first three quarters compared to the figure reported in fiscal year 2013. Despite a slight decline in return on assets, the higher returns on equity were achieved through lower cost of debt.

Shareholders' Returns

In this quarter Whole Foods Market generously distributed returns to investors as dividends declared per common share have jumped 20% compared to the third quarter of 2013 reaching 12 cents per share. It returned a total of $44 million in quarterly dividends. Additionally, the company repurchased $361 million of its common stock.

The board of directors at Whole Foods have canceled the $322 million in remaining authority under the company's existing share buyback program but also announced a new program for $1 billion that would be implemented from August 1st, 2016.

Valuation

Whole Foods Market's stock is not profitable based on its fundamentals. The stock is highly overpriced based on the company's multiples when we compare it to the overall industry average. This means that it won't be adding any profit to investors in terms of price appreciation.

Source: money.msn

Final Thoughts

Whole Foods Market has performed exceptionally well over the last few years. Revenues continued to grow the previous quarter as well and this growth is projected to be sustained in the future based on U.S. market trends and conditions. The company's debt profile and liquidity position also portray an interesting story. However, the depressed margins along with overpriced multiples are posing a threat. Investors would continue earning profits in the form of dividends from high revenue, earnings growth, and improving ROE but there still remains a threat that this stock, despite its high expectations, could crash in the future.

Source: Is Whole Foods Overvalued Compared To Its Peers?