Why You Should Be Bearish On Whole Foods Market

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Since my last bearish call on Chipotle Mexican Grill, Inc. (NYSE:CMG), the stock has plummeted 23.04% primarily on last week's disappointed earning release and revised fiscal year guidance. This is a perfect example that shows how lofty valuations relative to peers offer investors little margin of safety, and a slight miss on market expectations will likely trigger a significant price correction.

In addition to CMG, I am also shorting Whole Foods Market, Inc. (WFM) - another stock that is trading at unsustainable high valuations, and I am just waiting for one expectation blowout to profit from the potential price correction. This article will illustrate the rationales for my bearish call on Whole Foods.

My value analysis is based on a comp set of food supermarket operators in the US and Canada with somewhat comparable firm size in terms of market cap. I arrived at the estimated stock value by weighting values calculated based on four different NTM valuation multiples - EV/Sales (15%), EV/EBITDA (35%), P/S (15%), and P/E (35%). And the following comparable analysis is based on the table shown below:

Click to enlarge

At $84.03 per share, Whole Foods is trading at 12.7x the NTM EBITDA and 31.5x the NTM EPS. The market has a high expectation for the company as revenues, EBITDA, and EPS are forecasted to rise by a 2-year CAGR of 14.0%, 19.2%, and 21.5%, over the current and next fiscal years, which are much more robust than the peer average of 5.3%, 6.2%, and 16.3%, respectively.

Accounting for the growth prospects, WFM trades at a high PEG of 1.6x, compared to the group average of 1.3x. In terms of various profit margins and investment return metrics, Whole Foods also substantially outperforms the group averages, and only the ROE of 13.0% is marginally lower than the average of 13.4%.

Whole Foods has a robust FCF margin of 3.1%, compared to the average of just 1.1%. It has almost no debt, thus making its interest coverage ratio at an absolutely healthy level. The company also has the highest current and quick ratios currently standing at 2.0x and 1.3x, respectively, suggesting a very liquid balance sheet.

As such, I do agree that WFM should warrant a premium valuation, possibly at a premium between 20% and 30%. Nevertheless, the current stock price of $84.03 implies a whopping valuation premium of 137.2% over the four peer average multiples (see below), reflecting that the market is likely being over-optimistic on the company.

The over-optimism is also reflected by Whole Foods' estimated financial trends. The table below shows that all of the revenues, EBITDA, and EPS estimates have multiple upward revisions over the past 18 months (see below).

Putting a more reasonable, but still lofty, valuation premium of 50% over four peer average multiples results in stock value of $54.18, still suggesting a significant 36% downside (see below).

Bottom line, similar to CMG's pre-Friday valuations, Whole Foods is currently trading at a level that offers almost no margin of safety to investors. The current valuations are based on the assumption that the company can continue meet the market's increasingly optimistic expectations. But it is very likely that a substantial correction could be triggered by a slight miss down the road. To protect their capital, I strongly recommend investors avoid Whole Foods given its very unfavorable risk/reward profile.

Comparable analysis and valuation tables are created by author, estimates table is sourced from Capital IQ, and all financial data is sourced from Morningstar and Capital IQ.

Disclosure: I am short CMG, WFM.