Keep WFM Stock out of Your Cart

 | May 07, 2014 | 12:44 PM EDT
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What do you do with Whole Foods (WFM)? It's easy, you shop there. It's the best food store in the world, bar none, with tremendous value, terrific locations, amazing, fun stores and the best, most-delectable meals to go.

I love going there and use its catering department for literally every big family meal. The store down the block from me in Brooklyn is a marvel, a destination place that's pure entertainment with surprisingly low prices. It's a beacon in a once-seedy neighborhood, a neighborhood, one could argue, that turned because of Whole Foods.

Ah, but you don't care about that. You want to know what to do with the stock of Whole Foods, the one down 20% today alone after the company revealed disappointing earnings and a revised outlook down. The one down 33% for the year after guiding earnings down for multiple quarters in a row.

That's a tough question because the stock is still way up from where it was just a few years ago when the skies were bluer and there was much less competition. Sure, it is down more than 40% from the high, but we don't care where a stock has come from, we care where it is going. A company that has repeatedly disappointed Wall Street with its projections is a company that portfolio managers will pay less and less for its earnings over time. The shareholders and analysts will rebel until the stock gets so cheap on recently-cut earnings that it becomes absurd to let it go. This stock, at 24x earnings, with the average supermarket trading at 16x earnings, is still too highly valued.

But that won't always be the case because of two unique qualities about Whole Foods (the store). One is that there is no doubt that everyone who shops at Whole Foods before this quarter and the stock's subsequent decline is still going to shop there. Second, Whole Foods is NOT an average store. It's a best-of-breed operator that, at the end of the day, deserves a premium multiple to the industry and to the S&P because of how well it is run.

The problem, as we all know, is that the competition has come in aggressively. Well-funded competition, whether it be Trader Joe's, a private company that doesn't have to show comparison numbers and can cut prices at will, or Wal-Mart (WMT), with is everyday low price or Costco (COST) with its cheap fruits and vegetables or Kroger (KR) with a big space devoted to natural and organic or any one of the directly competitive stores that Wall Street has funded of late such as Sprouts (SFM), Fresh Market (TFM) and Fairway (FWM).

The good news? Whole Foods is a better operator than all of them. The bad news, in order to expand successfully and keep taking share it has to cut price on foods, hurting gross margins and dinging profitability. I have no doubt that Whole Foods will prevail in the long run. The short run? It's just a hard stock to own.

So, keep shopping Whole Foods, but don't shop for the stock yet. There are too many disappointed holders as this stock goes from being one of the great growth vehicles of our time to a true value buy because other retailers have figured out the category's too big to avoid competing. Whole Foods will ultimately win that competition, but until it does and its stock goes lower, the appetite for the food it makes and sells will far exceed the appetite for the stock itself.

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