Whole Foods: Don't Let Controversy Cloud Judgement

Whole Foods (WFMI) is an organic grocer that people love to frequent. However, this once darling of Wall Street is a fallen angel, with the stock plummeting from $80 back in December of 2005 to a recent $40. In fact, the stock is at the same level as it last was back in August of 2004.

The 50% drop in stock price over the last 18 months seems justified. After all, revenues have been increasing in low double digits, guidance has been poor, margins have been shrinking, larger competitors like Safeway (SWY) and Kroger (KR) have started selling organic foods, so there is plenty of competition and above all, earnings have been falling.

The most recent controversy surrounding the CEO of Whole Foods posting frequent messages on Yahoo Finance's message boards is another blow to the company. Or is it? The attention that the company will get from all the chatter about the CEO, not to mention the subsequent ouster of John Mackey, which seems to be on the cards now, might actually be a good thing for the stock. Perhaps this is one of the reasons the stock was up almost 4% Friday on higher than average volume. Either that or some of 14% shares shorted were covered.

With almost 200 stores, Whole Foods is still a young chain. in comparison, Safeway has over 1700 stores in US and Canada. But does Whole Foods really compete with Safeway? Perhaps it competes with Safeway's upscale Pavilions chain, but certainly not Vons or Randalls. Whole Foods' specialty is organic foods, but the shopping experience there is far more superior than at most other grocers.

The point here is not to be outright bullish or bearish on Whole Foods. I think there is a contrarian opportunity to be had here, but investors on either side will need to be patient and adventurous.

WFMI 1-yr chart:

Full Disclosure: I do not own WFMI but my position can change anytime without notice.

Comments

[Alan Brochs...:]

I wrote here in March that the stock was a dud and headed for 38. I recently wrote again that it might bounce at 38, but I don't think that there is anything but a potential trade here.

You are missing the big picture on competition. No, it isn't Vons or Randalls or Tom Thumb explicitly. As I wrote before, in Texas, the home of WFMI, Central Market (a division of HEB, one of the best grocery chains in the country - privately held) rules. Since beginning a diet recently (10 lbs in 4 weeks, thanks), I have really begun to understand why much better. Much wider selection of organic produce, poultry, beef and fish. But, there are several sources of competition, including those chains you mentioned as well as Kroger, WMT and others. The low-end "experience" can offer the same packaged good at a lower price. I buy hardly anything off the shelf at Whole Foods (I do buy coffee and stuff on sale, as well as water). For the high-end "experience", there are also a lot of alternatives developing, including the store-within-a-store at the big chains as well as places like Trader Joe's.

Whole Foods was a great idea, but it had no patents. Its successes are being copied all over the place now. The employees were always quite happy - like those of Southwest Airlines (when its stock was going up, when times were good enough that management didn't have to mess with labor).

I do agree with your conclusion. I think that the stock could have a decent quarter if they don't disappoint or if they somehow are able to snag OATS, but I expect more rear-view mirror holders to unload before year-end. I think that over time, the company will go back to the drawing board and try to innovate/differentiate its way out of this quagmire, but I think it could take a long time. In the end, the company's multiple will move to a level that more properly reflects its future margin potential.

2007 Jul 16 06:29 PM