Whole Foods: Not That Appetizing


Shares of WFM are down big on heavy volume following a weak Q3 ER.

Comps continue to be negative despite the lap getting easier.


Mass market organic competition continues to intensify, and we do not think the rich valuation accounts for these competitive risks.

Shares of Whole Foods Market (NASDAQ:WFM) are down big on heavy volume following a disappointing ER, which saw comps continue to falter. We think the story here is troubled, and that the rich valuation does not fully account for risks presented by the mainstreaming of natural organic.
The quarter’s -2.6% comp was better than Q2’s -3% comp, but it also lapped an easier comp (2.2% versus 3.6%). The most troubling thing is that early Q4 comps are still trending around -2.4% despite lapping a much weaker 0.6% early 4Q15 comp. The lap is getting easier, but the comp isn’t improving in a way that shows the business is rebounding.

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We think this harks back to our original bear thesis on WFM: the mainstreaming of natural organics presents a huge risk to the company’s long-term growth story. Since our first report, shares have cycled but are in total down 15%. We think mass market threats have only magnified since July 2015, and now that comps have turned negative, we believe WFM is more susceptible to this threat than we originally postulated. The valuation does not account for these competitive risks, and we think the stock has significant valuation risk at these levels.
The competition is coming from everywhere. Wal-Mart (NYSE:WMT) is aggressively expanding their Grocery Pick-Up service, growing from 22 markets at the start of the year to 40 by the end of May. The company is also testing different delivery options for optimal efficiency, including leveraging Uber and Lyft’s driver networks. Meanwhile, Target (NYSE:TGT) is also ramping up its grocery operations. The company did a reset in April, adding 1,000 new items, including a plethora of organic and gluten-free options. Kroger (NYSE:KR) continues to expand its natural and organics line, including investing in specialty organic grocer Lucky’s Market, and results there have been quite positive recently. Then there’s Costco (NASDAQ:COST), Trader Joe’s, and a handful of other grocers across the country that sell what WFM sells, but for much less.

The problem is, has always been, and will continue to be WFM’s prices. They are significantly higher across the board. While this high ASP model used to work, its efficacy has started to erode. WFM was an exclusive shopping experience, and shoppers agreed to pay a premium on products for that exclusivity. The mainstreaming of organics is shedding away WFM’s exclusivity, and consumers are finding it difficult to rationalize spending an arm and a leg for what can be bought for 50% less at TGT, WMT, or KR. While 365 offers WFM an opportunity to recapture value-oriented customers, WFM only has two 365 stores open and the chain is still in the early, speculative growth stages. 365 needs more proof of concept before WFM is investable.

As the stock currently stands, WFM is overvalued. It trades right around 19.5x forward earnings on EPS that is declining. Even often overly optimistic sell-side analysts only see a 6% earnings CAGR over the next 5 years. By comparison, WFM’s mass market competitors trade at mid-teens forward multiples, and earnings at KR and TGT were both up last quarter.

WFM is too richly valued to take a bet on the 365 rollout. Mass market organics are clearly having an adverse affect on WFM, and the growth story is greatly at-risk as TGT and WMT both advance their grocery initiatives. We expect shares of WFM to continue to fall.

For more information: Seeking Alpha

Fuente: Seeking Alpha

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