Whole Foods' Strong Growth Alone Does Not Make It Attractive

Aug. 2.12 | About: Whole Foods (WFM)

Whole Foods Market (WFM) continues to stand out among grocers, reporting yet another stellar quarter. During its fiscal year 2012 third quarter, the grocery store chain, known for its healthier product offerings, saw same-store sales increase 8.2% in spite of the Easter and 4th of July shift. Total sales surged nearly 14% compared to the same period a year ago to $2.7 billion, which was in-line with expectations. Earnings per share grew 26% year-over-year to $0.63, which was slightly more than the Street expected.

As a result of strong earnings growth, the firm generated $401.3 million in free cash flow during its third quarter. This is quite different from its older competitors-namely SuperValu (SVU), etc--which have struggled to produce enough cash to reinvest in its stores. Whole Foods' business strategy of catering to higher income shoppers looking for organic and specialty foods is working incredibly well, allowing it to charge higher prices and earn gross margins that exceed traditional grocers.

In addition to strong third quarter results, Whole Foods Market hiked revenue and earnings guidance due to strong performance in the beginning of its fourth quarter, with same-store sales up 9.7% thus far. The firm expects revenue growth to exceed the top end of its previous 14.8%-15.6% range during fiscal 2012, driving earnings per share growth of 30%-31% versus a previous expectation of 26%-28%. Management also reiterated its belief that the firm still has room to more than triple its store base over time.

Growth remains firmly intact at the grocer, but we think shares are pricey at current levels, trading above our fair value range. The firm also currently scores a 4 on our Valuentum Buying Index (our stock-selection methodology), suggesting that shares are relatively unattractive. The stock currently trades around 37 times 2012 earnings, which is a far greater multiple than other grocers, which tend to trade at high single and low double-digit multiples.

Whole Foods is creating a lot more value than any of its peers and shows little sign of deteriorating fundamentals, suggesting that it deserves a relative valuation premium. However, the firm may not be able to maintain such high gross margins over the long-run since the grocery business is highly competitive and other players will likely emerge and steal market share. We'd stay away from shares at current prices.

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