Why You Should Sell Whole Foods

| About: Whole Foods (WFM)

People are more health-conscious now than they have been at any other time in recent history. Even fast food restaurants now shout about how healthy their latest ‘wrap’ or whole wheat sandwich is. Whole Foods Market Inc. (NASDAQ:WFM) operates a store that provides healthy eating solutions to customers – groceries, seafood, meats, baked goods and produce – that are in the range of of natural and organic food. WFM also sells speciality items like body care products, beers, wines and household goods.

WFM shares are currently trading around $72, and the mean 12 month price target from analysts researching the stock is $74.47 (3.5% upside potential). This stock is trading above its 50-day exponential moving average of $66.32 and its 200-day exponential moving average of $60.01. Though suffering a pullback in August with the general market, the stock's rise has been almost unimpeded during the past twelve months, and it now sits just below its 12-month high of $73.33 and 88% above the 12-month low of $38.35. The shares have traded above a rising 50-day EMA throughout this period, and may look set for a further advance. However, caution should prevail; the shares are trading near the all-time high of around $78 made in early 2006 and after the company made profits of $1.98 per share in fiscal 2005.

Earnings per share for the last 12 months are $1.85, and these are expected to reach to $2.26 in the next fiscal year (ending Sep 2012). These numbers place the shares on a trailing price to earnings ratio of 39, and a forward multiple of 31.86. Based on this price to earnings ratio, the market clearly believes that WFM has a greater growth potential than competitors such as The Kroger Co. (NYSE:KR), where the trailing price to earnings ratio is 12.03, and Safeway Inc (NYSE:SWY), where the ratio is 12.74.

For investors looking at dividend-paying stocks, WFM’s payment of a dividend of $0.40 last year gives the stock a yield of 0.60%, and this is covered by 4.6 times by its earnings. This compares with SWY’s dividend yield of 3.20% (covered 3 times) and KR’s yield of 2% (covered 4 times).

Current operating margin at WFM is 5.48%, with a return on assets of 8.43% and a return on equity of 12.62%. In comparison to SWY, where operating margin is 2.88%, and return on equity is 11.27%, these figures look favorable. The current revenue from WFM’s income statement is $9.85 billion, and last quarter’s revenue showed year on year growth of 10.90%. WFM has $536 million in cash and a total debt of just $18 million. The company’s debt/ equity ratio is a miniscule 0.63.

Shareholders in WFM have had some of the best returns achieved by equity investors over the past twelve months. The stock has massively out-performed the S&P 500 Index, and the shares of SWY lag even further behind. Believers in the health food concept will point to WFM’s market position, its healthy debt position and its twelve month trading pattern as proof that the stock remains a buy at these current levels.

However, with consumers becoming increasingly cash conscious, as income stagnates and job losses mount in a weak economy, many will find it difficult to justify spending extra money on organic foods. Thus far, WFM has weathered this gathering storm, and marketing techniques such as extolling the virtues of its produce to combat cold and flu may help sales further. But at some point, the cash in pocket counts: if it’s not there, consumers can’t spend it. Consumers may find themselves financially forced to turn to cheaper options. In such a scenario, the supermarket price wars will heat up and margins at WFM will be eroded.WFM also pays a miserly dividend when compared to peers. A 0.40% yield is not a reason to buy the shares.

The shares are at a price now where the price to earnings ratio is at a huge premium to its competitors. The last time the share price was this high was in 2006, when earnings were around the same level as today and the stock traded at a similar price to earnings multiple. The next earnings release may be the last one that meets or beats expectations; a tightening economy will lead to tightening wage packets, tightening spending and tightening margins at WFM. I see no reason to chase the shares, and believe that current holders should take profits into any further rise. Sell.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.