Don't Add Whole Foods to Your Cart

 | Jun 05, 2014 | 9:00 AM EDT
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In November, I thought there would be more indigestion ahead for Whole Foods (WFM). I believed growth was slowing, margins were getting squeezed and the competition was heating up. Turns out I was right. Since I wrote that article, the stock has fallen 33%. Since the shares have declined so much now, is this the time to go shopping and add this food retailer to your cart? 

On May 6, Whole Foods announced its third consecutive disappointing quarter. The company missed second-quarter EPS estimates by $0.03 and issued downside guidance for the remainder of the year. Sales for the March quarter rose 10% to $7.6 billion, but net income only rose 4% to $300 million.

If that wasn't enough, management said earnings, revenue, margins and same-store sales would all be lower than expected for the remainder of the year. They cut revenue growth from 11%-12% to 10.5%-11% and same-store sales were chopped to 5%-5.5%.

As early as fiscal 2012, sales rose 15.7% and earnings per share were growing by 30%. Then, in 2013, the company hit a wall. Revenue grew just 10.4%. The days of 8% same-store sales are long gone.

Although management recognized the sales slow down, I don't think they understood the extent of the weakness in their business. Competition has really heated up. Whole Foods hasn't brought down its gross margin enough to entice customers to return to the stores. In my opinion, management hasn't done enough to build traffic. Gross margin is still in the 34%-36% range. (Gross margin in the March quarter was 35.85%.) Kroger (KR), for example has a 19% gross margin. Lowering the margin could help drive traffic into the stores.

Since the company can only generate 5% comps, it seems clear that consumers still tag Whole Foods with the "whole paycheck" moniker. Until management addresses that perception, I think the stock will go lower. Trading at 22x forward estimates, the stock is expensive for a company that can only put up an estimated 10%-11% revenue growth.  

While WFM is well off its highs, I would have to see a consistent increase in same-store sales for me to become interested. For now, I wouldn't put this stock in my shopping cart.

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