Whole Foods Market: Expect 60% Long-Term Gains

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Summary

WFM will benefit from an improvement in consumer spending on the back of economic growth in the U.S. while a smaller store format will be another tailwind.

The 365 store has an area of 28,000 square feet, which is around 43% lower than its normal-sized store, leading to 50% lower costs and earnings improvement.

Due to lower costs, WFM can keep prices of items 23% lower and deploy its smaller stores into new markets, which will lead to top-line growth.

Earnings growth in the next four years will lead to 60% upside, while next year itself, the company is expected to deliver 13% gains due to sales growth.

In 2017, Whole Foods Market (WFM) might prove to be a winner. In my opinion, Whole Foods will be able to capitalize on further growth in U.S. consumer confidence on the back of its new store concept, which will allow the company to reach more customers. Eventually, WFM will be able to take advantage of the growing demand for organic foods in the U.S., which will enable it to increase its sales and earnings.

As a result, I think that Whole Foods is primed to deliver upside in 2017 and in the long run as well. Let me explain why.

Two factors that will help Whole Foods enhance sales and earnings

Consumer confidence in the U.S. has been soaring of late. This month, consumer confidence in the U.S. soared to a 15-year high due to the election of Donald Trump as the next American president. The improvement in consumer confidence is a result of an improving perception of the economy.

Before the election, only 15% of Republicans were of the opinion that the U.S. economy will improve. After the election, that number has gone up to 58%. Driven by election results, consumer confidence has reached 113.7 in December as compared to 109.4 last month. This improvement in the consumer confidence is the function of a growing economy, as the U.S. GDP grew at a rate of 2.9% in the third quarter, which was the strongest in the last two years.

As a result of economic growth, more Americans are gaining employment. This is evident from the fact that the unemployment rate in the U.S. has dropped to a nine-year low of 4.6% as the average employment addition each month in 2016 has been over 180,000 jobs. As more jobs are created, disposable incomes in the U.S. rise, which is why consumer spending is picking up pace.

The rise in consumer spending can be expected to continue next year as the economy is expected to continue growing at a rate between 2% and 3% in 2017. As a result of stronger consumer confidence, retail sales can be expected to increase next year, which will be a tailwind for Whole Foods as it launches its smaller stores.

More specifically, Whole Foods is set to launch more of its 365 stores going forward due to their smaller size and the potential to attract more customers. In fact, the company has 19 leases signed for its smaller 365 stores, and will be launching 32% of these stores in new markets. The advantage with the smaller size stores is that they cost less to build and operate while being deployed in markets where the population is dense.

The average size of a 365 store is 28,000 square feet, which is around 43% lower than its normal-sized store. As a result of being small, they cost 50% less to build and operate, which is why Whole Foods can open a higher number of smaller stores as compared to a few large ones in order to tap more customers. Additionally, the cost of items at a 365 store is around 23% lower as compared to a normal store, which is why it can gain more traction going forward.

This is not surprising as, due to low operating and capital costs, Whole Foods can afford to sell items at a cheaper price in the 365 stores. This is a smart strategy, in my opinion, as it will allow Whole Foods to enhance revenue and reduce the costs at the same time, which will eventually lead to earnings growth.

Impact of higher sales and lower costs on the stock price

In the current fiscal year, Whole Foods expects its bottom line to drop around 6% as compared to last year as it makes investments in its stores. But, from the next fiscal year onward, Whole Foods will be able to deliver growth in its bottom line.

In the next fiscal year, earnings will increase to $1.46 per share as compared to the expectation of $1.45 per share in the current year. Eventually, by 2020, Whole Foods will be able to increase its bottom line to $1.69 per share, which is a rise of over 16% from current levels. Now, if earnings do reach $1.69 per share in 2020, the company's stock price should increase to around $52 per share, considering its five-year average P/E ratio is 31.

This means that, in the next four years, Whole Foods is capable of delivering more than 60% upside as compared to current levels. More importantly, investors can expect the company to deliver upside going into 2017 as well. This is because its sales are expected to increase to a maximum of $17.7 billion next year as compared to an average of $16.2 billion this year, indicating a rise of more than 9%.

If Whole Foods manages to achieve $17.7 billion in sales next year, the company's market capitalization will increase to $11.3 billion (assuming it will trade at its current price to sales ratio of 0.64). As compared to the current market capitalization of $10 billion, this means that Whole Foods' stock price will increase around 13%.

Conclusion

Whole Foods Market has gained impressive momentum in the past three months, rising close to 12%. Next year, it is likely that the company will be able to sustain its momentum in light of the points discussed above. As my analysis suggests, Whole Foods will deliver decent gains in 2017, and for the next four years as well. It looks like a good bet.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.