Whole Foods: A Stuffing After the Turkey 10 comments
-
Font Size:
-
Print
- TweetThis
As I had anticipated earlier this month, Whole Foods (WFMI) (40.75, $5.7 billion, S&P 500 member) disappointed investors yet again. Since peaking in late 2005, the stock is now down almost 50%. While same-store sales were actually a bit stronger than I had expected, profitability was significantly lower than anticipated. I had thought that many investors were excited about instant gratification from the recent large acquisition of rival Wild Oats, but that isn’t the case. As always, the conference call was quite interesting. The comment that struck me the most is that CEO Mackey doesn’t believe the company is a luxury retailer. This is the same guy who over the past few years has told us it isn’t a grocery store either. Of course, he also has admitted in the past to not knowing why the same-store sales had been so strong in the early part of this decade or why they had suddenly weakened last fiscal year.
Rather than rehash my views on the stock (too expensive relative to growth prospects amidst rising competition and a challenging macro-economic environment), I would like to discuss that WFMI actually is a luxury retailer and increasingly a grocery store (in the negative sense of that term).
One of the myths out there about Whole Foods Markets, I mean, is that we are some kind of luxury retailer and we get once in that category and whenever the economy gets weak everybody comes out and says: “gosh, Whole Food sales are going to fall”. However, that's never been the case. We've been doing this for 29 years and every time there is a recession our sales don’t fall, in fact, during the recession our comps went up into double-digits, they increased during the recession.
John Mackey, CEO in response to a question by Simeon Gutman of Goldman, Sachs
Source: Transcript provided by Seeking Alpha
First, how can WFMI not be a luxury retailer (if not a high-end grocery store)? The company physically resembles a luxury retailer in terms of its appearance (marble, good lighting, display). Second, in the categories in which it competes, it tends to offer the highest quality products. Finally, check out all of the “luxury” automobiles in the parking lot – guilt by association! As far as discussing the last recession, it was a capital spending recession not a consumer recession as this one is/will be. The prior recession was in the early 90s, when the company was so small it isn’t relevant to anticipating how a weaker economy might affect demand at its stores.
Grocery stores are traditionally a safe-haven during times of economic weakness due to the ongoing demand for food no matter what. While Mackey has suggested that WFMI isn’t a grocery store, they really are. They were a completely different type of grocery store, but many of the more traditional ones have learned from some of their remarkable business practices. While being a grocery store in a recession isn’t such a bad thing to be, I would argue that it is if you have a 27PE. I can remember evaluating WFMI earlier this decade, and one could argue that it really wasn’t a grocery store in terms of margins and balance sheet. 7 years later, that is clearly a questionable statement. In the most recent quarter, this is what it looked like:
WFMI still maintains higher GM, which has been constant over the past several years. The EBITDA margin has dropped due to the recent acquisition. Even adjusting though, the two other large chains have expanded their profitability over the past few years, while WFMI has not. WFMI, historically known for its superior capital structure, has downgraded its balance sheet significantly in buying Wild Oats. 2007 had been described by management as a “transition year” for WFMI, but clearly 2008 is as well, with EPS forecast to be up single-digits and well below the other two peers. Will investors continue to pay up so much in advance of the return that is continually pushed out?
I am sticking to my view that this is a horrible time to be a shareholder at WFMI. The earnings estimates are probably going to continue to decline. The PE will almost certainly decline. The company is expanding too rapidly (beyond just the big acquisition) while not having a better handle on its existing base of stores. Capital spending next year is supposed to be about $600mm, which is a massive number in comparison to the operating cashflow that the company will generate. I expect that the stock will trade in the next year between 44 and 31, with a year-end 2008 price target of about 35 (1.60EPS-FY09*22PE).
Disclosure: Short WFMI
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 10 comments:
I also have to disagree with the luxury retailer comment. I shop at Whole Foods all the time, and know for a fact that the prices are competitve if not even better than the competition, all while getting prducts that are at the least all natural. If you were to compare in house Whole Food's line of products (365, 365 Organic, Whole Kids, and more) to the in house brands of Safeway, Kroeger, and the rest if the competition, you will find they are priced about the same, with the added benefit that the products at Whole Foods will have no artificial flavors, sweetners, colors, preservatives, GMOs, etc. The whole "luxury retailer" perceptions comes from the fact that Whole Foods carries a wide range of choices. For example, the in house 365 Olive Oil might only cost $4.99 for a 16 oz bottle, but if you look at their Olive Oil that is Organic and is imported from Italy, you'll see it costs $22.99 for a 16 oz bottle. People see the higher price, latch on to it, and then the "Luxury Retailer" and "Whole Paycheck" rumours spread.
seems the yahoo message board even understands the margin dynamic...i've copied and pasted for your education...
"the company has been investing heavily in new store openings...due to abstract GAAP accounting rules, the company has to recognize lease expenses on the income statement before the store actually opens (consequently no corresponding revenues and therefore downward pressure on margins) -- however this is just an accounting dynamic that has no implications for the cash margins of the business...
further, new stores by their very nature carry lower cash margins than mature stores due to lower sales volumes...consequently... in periods with large numbers of new store openings, margins will naturally experience some downward pressure -- this is NOT an implication of weak business trends...quite the contrary, it reflects new store openings, which are tremendously POSITVE for shareholders...as revenues grow in the new stores, the corresponding margins will approach those of the mature stores...
in addition to opening a record number of new stores in fiscal 2008, the company will also be incurring one time expenditures related to the integration of wild oats, which will temporarily pressure margins...these one time outlays should largely be over as we head into the fourth quarter of fiscal 2008...and the longer term benefit of such one time expenditures will be enormous as the wild oats stores realize sales volume and efficiency gains similar to those of a whole foods store, resulting in meaningful incremental cash flow in the future...
in 2008, the company will continue to invest in industry leading healthcare coverage for employees....this is a great investment -- happy employees = productive employees and happy customers, the combination of which will help margins rise in the future...whole foods has repeatedly been recognized as one of the best employers in the country, which further strengthens the company's position as an employer of choice...given that whole foods is so far ahead of its competitors in terms of investing in employee healthcare, any future expenditure increases on this front should have modest impact on margins as the combined benefits outweigh the cash outlays...
with all of that said, it is still NOT clear that margins will decrease in any meaningful way during fiscal 2008, which provides good insight into how strong the business is performing...and guess what is crystal clear -- margins will EXPAND in fiscal 2009 as the temporary pressures on margins subside....
as for valuation, your arbitrary assertion re the appropriate PE multiple for whole foods represents the height of ignorance...the E you use in your analysis is artificially depressed and therefore not relevant....personally... i have no clue what the stock price will do over the near term but i do know that the stock price will be MUCH, MUCH higher over the long term...
and here is the most important fact for shareholders to digest...comparable store sales are ACCELERATING during a period when fear mongers are asserting that the US is experiencing a recession, borderline depression in some states...specifically, for the first seven weeks of the fiscal 2008 first quarter, comparable store sales growth was 9.5% and identical store sales growth was 7.2%. In the immediately preceding quarter (4Qfiscal 2007), comparable store sales increased 8.2% and identical store sales increased 6.0%. This company’s business is continually IMPROVING during a period when virtually every other retailer is struggling…Whole Foods has a tremendously strong and robust business that will benefit shareholders for many years to come."
Artificially depressed "E"? They are generating negative free cashflow - sorry, you can't say that. You believe that that the E is depressed because you give them credit for improving the margins post-Wild Oats
Same-store sales aren't accelerating! They are benefitting from food inflation. Get real! In any event, they aren't what they used to be.
I did very well shorting COH, which is probably still a sell. I see that their EBITDA margins are in the low 40s and their NI margin is in the mid-20s. WFMI has EBITDA margins of no better than 8% and NI margin of no better than 3%. You better be careful, as COH trades at just 16X while your beloved WFMI trades at 27X. Good luck with that...
Allow me to give you some free unsolicited advice:
WFMI is to SWY as SBUX is to MCD
"Obfuscation from a large merger." -- 2008 GAAP results would actually "look" better if the company hadn't acquired OATS...one time integration costs associated with the OATS acquisition depress margins over the near term -- so no obfuscation in the way you implied (although you did impress me with the big word).
"Artificially depressed "E"?" -- YES, re-read comments above re the cost dynamics and GAAP accounting.
"They are generating negative free cashflow" - CFO will be very strong in 2008. Cap exp will indeed exceed CFO but only because the company is investing heavily in new store expansion, which is very positive because such investments will yield meaningful incremental cash flow in the future.
"Same-store sales aren't accelerating! They are benefitting from food inflation. Get real!" -- check your premise and re-read the facts. Not going to explain the basics of the Whole Food business model to you.
"I did very well shorting COH, which is probably still a sell." -- who cares???
"Allow me to give you some free unsolicited advice: WFMI is to SWY as SBUX is to MCD" -- and here is some advice for you, get out of your ivory tower and walk into a SWF and then a Whole Foods...you'll no longer make ridiculous comparisons as a result of finding that the shopping activity at a Whole Foods far exceeds that of a Safeway all of the time -- there is really no comparison. And to reiterate a fact that will bring this home for you in case you can't get out of the office -- Whole Foods avg. revenue/sq foot is app $950 vs $450 for a Safeway. Safeway will certainly have it's place in the world but they will in no way impede the growth of Whole Foods.
Who knows what the stock will do over the near term but long term, the stock is going much higher. Enjoy.
Why do you assume that the massive capital spend in front of a recession like we haven't seen in over 15 years will be successful?
Why do you not see that I am not arguing that Safeway is better than WFMI just that it offers consumers similar products at lower cost? The analogy to SBUX and MCD is one of trading down, something that millions of consumers who have enjoyed raiding the home piggy-bank will have to incorporate into their lives.
Why isn't COH a fantastic example of another luxury-oriented retailer that has both higher margins and a much lower valuation?
You are very caught up on how high the psf sales are. I see this as a risk - they are expanding like gangbusters assuming that they can keep this up. I see this as confirmation of my characterization of the company as a "luxury retailer" (high-end at any rate).
The competition is intense - not just grocery stores adapting but also Tesco coming in, Trader Joe's etc.
It seems as if I were to point out that there was a huge pothole in the parking lot of my local WFM, you would find some discrepancy in that statement as well. So, I will defer to the market to decide if I have evaluated this situation correctly.
"Well, it looks like both the market and I aren't as clued in to the story as you are." -- the stock has compounded capital at a 21% annual rate since going public. So the market has indeed been clued into the story and rewarded shareholders handsomely over the long term. Stocks bounce around over the short term -- e.g., as a result of irrational fears gripping traders/speculators... Substantiating your view based on short term stock price movements is the height of foolishness. During the very long period over which WFMI shares have compounded at 21% annually, there have been short term declines in the stock price equal to or greater than what has been experienced recently -- these were fantastic buying opportunities.
"Why do you assume that the massive capital spend in front of a recession like we haven't seen in over 15 years will be successful?" -- because a recession has never affected the Whole Foods business. In fact, during a period when the California economy is essentially experiencing a recession, the Whole Foods business is IMPROVING in this state. Further, Whole Foods stores are wildly successful (not one has ever failed) while recessions are transitory by nature...so any short term adverse effects of a recession on the Whole Foods business (which again has NEVER happened -- people still eat every day) would be just that short term and have no impact on the long term success of the new stores.
"Safeway offers consumers similar products at lower cost?" -- not true...again, go to the stores. There may be overlap on some products but in these cases the prices are very comparable. Further, the quality and breadth of the Whole Foods product is far superior to that of Safeway -- customers seem to be voting with their feet. You also can’t trust what you’re getting from conventional retailers – carbon monoxide infused beef for anyone????
"The analogy to SBUX and MCD is one of trading down, something that millions of consumers who have enjoyed raiding the home piggy-bank will have to incorporate into their lives." -- Interesting speculation but not consistent with reality. Unlike virtually every other retailer, Whole Foods same store sales are ACCELERATING.
"Why isn't COH a fantastic example of another luxury-oriented retailer that has both higher margins and a much lower valuation?" -- one of your more fundamental misjudgments. Whole Foods is not a luxury retailer (healthy food/groceries are a necessity not a luxury) and therefore has much less risk of a material decline in their business as a result of an economic downturn. To repeat, unlike virtually every other retailer (high end or low end), Whole Foods same store sales are ACCELERATING.
"You are very caught up on how high the psf sales are. I see this as a risk - they are expanding like gangbusters assuming that they can keep this up. I see this as confirmation of my characterization of the company as a "luxury retailer" (high-end at any rate)." -- ?????????? high productivity = luxury retailer ???????????
"The competition is intense - not just grocery stores adapting but also Tesco coming in, Trader Joe's etc." -- SAME STORE SALES AT WHOLE FOODS ARE ACCELERATING -- management has consistently shown an ability to adjust and adapt to changes in the competitive environment. Further, the market is plenty big enough to support other high quality food retailers. Unionized, conventional food retailers with outdated stores will get eaten alive over time. Additionally, Whole Foods treats its customers, employees, and the local community far better than conventional competitors like Safeway -- this matters as the numbers/facts have shown.
"So, I will defer to the market to decide if I have evaluated this situation correctly." -- The success of any company is measured over the long term and it is the CUSTOMERS who decide not the market.
Good luck.