Whole Foods (WFM) stock is currently trading close to its 52-week high versus its low of $62.44 on 10/3/2011. This stock has become a wall street darling among those looking to invest in a growth story. Here, we discuss the various catalysts that could potentially trigger a further upside in the stock.
Stock valuation: Whole Foods stock is currently trading at a P/E multiple of 39x 2012 consensus EPS of $2.52 and 34x 2013 consensus EPS of $2.90. This is in comparison to its closest competitor The Fresh Market (TFM), which trades at 41x 2013 consensus of 1.39. Over the past 10 years, WFM has traded at an average P/E multiple of 29x with a peak of approximately 52x and a trough of 10x during the recession. Whole Foods is a great growth story and a well run organization. The management of Whole Foods has made tremendous progress since 2007 when it first started restructuring the organization. Today, Whole Foods stock has the potential to continue on its growth path unlike many traditional grocery chains that thrive on thin margins and continuous liquidity issues.
Positive factors contributing to a possible growth in valuation:
Health conscious consumer: The U.S. is definitely gearing towards becoming a healthier nation. There are the McDonald's (MCD), Starbucks (SBUX), and Dunkin Donuts (DNKN) that are providing healthier options, and then there is Whole Foods that is making food more affordable for those who opt for more organic food. Food safety being the prime reason why the consumer is moving towards organic groceries. Whole Foods, which is America's first "Certified Organic" grocer, is now focusing on providing more convenient locations and more affordable food.
Big surprise on pricing: Whole Foods nickname "Whole Paycheck" might need a change. In comparison to some of its competitors, WFM products priced only 5% above Trader Joe's, and 14% below The Fresh Market. Additionally, the company's 365 private label brand is actually 20% below conventional grocery pricing. The effort the company has made will attract more price sensitive consumers who would prefer to eat healthier.
State of the real estate market and the retail sector works to their advantage: As consumers move towards online shopping, stores such as Best Buy (BBY), Barnes and Noble (BKS), and Circuit City will have to shut down some of its stores. This will be a great opportunity for Whole Foods to step-in and grab that space. Today, Whole Foods is not restricted by the availability of capital to buy real estate, but is restricted by capturing the most profitable locations.
A hefty cash balance might mean a dividend increase: As per quarter ended June 30th 2012, WFM has available cash of $1 billion. This is significant for us to believe that a possible share buyback or a dividend increase might be a near-term kicker for the stock.
A disciplined grocer in a recessionary market: WFM has made some smart decisions in the 2007-2009 period. Before the recession, the average store size was as high as 50,000 square feet, which only meant pressure on margins due to high rents and opening costs. Cash burn increased to $1b in 2007-2008, which was followed by the suspension of the dividend. The CEO reacted quickly and took advantage of the depressed real estate market by re-negotiating leases and cutting down square footage. Today, the average new store size is 30,000 sq. Ft. The overhaul of operating costs has lead to the hefty cash balance of $1 billion.
In addition to any drop in sales growth caused by a lack of spending by price sensitive customers, we think food inflation could have a significant impact on top line growth and earnings. Keep in mind that more than 50% of the U.S. is experiencing drought conditions.
We also think that investors are now used to Whole Foods "Beat and Raise" track record, and if this changes, it could be a huge disappointment for the street that could result in a downside in the stock.
Written by Sabina Bhatia