11/11/2013 Covered Call Pick: Whole Foods Market (WFM)
Whole Foods Market (WFM) is an American-based supermarket chain specializing in high-end, organically sourced produce, meats, and packaged products. Operating over 360 organic supermarkets in 40 U.S States, Canada, and the U.K., Whole Foods Market is the world's largest supermarket chain that is directed towards providing "natural", aka minimally processed, organic foods in a sustainable manner to its customers.
Whole Foods Market has a market capitalization of $21.81 billion with 372.5 million outstanding shares.
WFM currently pays a $0.10 quarterly dividend for a current yield of 0.8%.
With a beta of 1.19, WFM trades with approximately 20% more volatility than the current market.
If you are a stock hound and have been following WFM, you might be slightly surprised to see it end up on here as a recommendation for this week's Covered Call Pick. That is because you are probably aware that the company reported 4th quarter earnings last Wednesday, which while they met their EPS and revenue estimates, fell short on comparable same store sales estimates and adjusted 2014 sales guidance accordingly. This caused shares to tumble over 9% in after-market trading and sending analysts running for the hills to get away from the stock.
While it is always rough to see a stock fall like that, especially if it is currently in your portfolio, it should not be forgotten that moments like these can be used as a buying opportunity. Scenarios such as this though are normally very stressful on the near-term performance of the stock. So when we run across a moment such as this for a stock that we feel strongly about, we inherently ask two questions: What are the long-term growth prospects like, and has the story changed?
Let's start with the story. The story for Whole Foods is based off of the belief that the diet of the average consumer is becoming skewed more towards healthier options, and that the organic and natural foods provided by a company such as Whole Foods is becoming a more desirable choice for the consumer. We believe that this trend is valid, sound, and strong. According to the Organic Trade Association's 2011 Organic Industry Survey, the organic food industry has grown at an average rate of 17% over the last ten years - including a growth of just over 5% during the Great Recession when overall food retail sales were flat. At nearly $27 billion in revenue, the organic industry has undergone a nearly five-fold increase since 2000, and has no real indicators that it is slowing down. Whole Foods, as the first certified Organic Grocer in the United States, and the largest player in organic and natural foods, has and will allow the company to obtain a disproportionate share of growth in the industry moving forward, as the health-conscious dietary mindset continues to propagate amidst the prevalent growth of diseases such as diabetes.
This moves us onward to Whole Foods growth prospects. The stock's downward plunge was based off of the lowered forward guidance for the next year in terms of sales growth. Sales are now expected to increase by 11-13% in 2014 as compared to 12-14% previously suggested, and comps are expected to increase between 5.5-7% as compared to the 6.5-8% of previous guidance. The company also stated it believes that the economy is slowing in the near-term which will end up putting additional pressure on sales moving forward. In terms of future growth prospects, this doesn't bode well for a positive investment thesis on the stock.
Yet instead of focusing on just what sales are going to look like next year for the company, let's evaluate the larger picture. Whole Foods is taking part in an aggressive expansion plan set forth that aims to open 32-38 new stores per year for the next 5 years. With only 350 stores in the U.S., and analyst estimates of the potential to have 1,000 U.S. locations before saturation becomes an issue, WFM has a large opportunity to take advantage of the organic foods story. We also believe that management is effective enough that they have the ability to expand without causing their existing business to suffer. Gross margins increased by 0.40% to 35.7% in the prior quarter, with operating margins increasing by 0.50% to 6.5%. The food retail industry is a low-margin industry, so to see this growth while the company is aggressively expanding is a positive sign, and we believe we could see long-term margin expansion as the increase in scale can help WFM drive down costs.
Lastly, while the stock price took a tumble last week, it has landed squarely inside a buy range of $57-$60, with a strong intermediate-term support level at $57. We think that, even with the lowered guidance moving forward into next year, this represents a positive time to enter into the stock. That is why we are recommending buying WFM and selling the May 2014 $65 Call.
- Buy 100 shares of WFM @ $58.85 = $5,885 + Commission ($12.95) = $5,897.95
- Write 1 WFM May 2014 $65 Call @ $1.98 - Commission ($8.70) = $189.30
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration
(1.89 + (2*0.10))/58.98 X (365)/186
= 6.95% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(1.89 + (2*0.10) + 65 - 58.98)/58.98 X (365)/186
= 26.98% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.
Disclosure: I am long WFM.
Additional disclosure: As active managers of individual portfolios we will buy and sell positions as needed and suitable for our clients.