Whole Foods Market (WFM) lost its edge as the leading organic whole foods grocery store chain. This is evident in 5 consecutive quarters of comp store sales declines. Increased competition for healthier organic foods is coming from Amazon (NASDAQ:AMZN) through the Amazon Fresh food delivery service. Most grocery store competitors are also selling more organic and healthy-related foods, taking market share away from Whole Foods. The company's future growth is too low to support the current valuation. Therefore, the stock is likely to decline over at least the next year or two, perhaps longer.
Fresh, organic foods are sold through Amazon Fresh at competitive prices and consumers don't have to leave their house as it is delivered directly to them. Fresh items such as organic milk, grass fed beef; produce, eggs, cheese, etc. are available for delivery directly to consumers through Amazon Fresh. This is likely to take market share away from Whole Foods as busy health conscious consumers point and click for their grocery shopping.
There are also many other competitors offering organic and healthy groceries. Kroger (KR) sells $11 billion worth of natural and organic products. Wal-Mart (WMT) is also selling a wide variety of organic/healthy products. Aldi has been ramping up its selection of organic foods. Aldi sells organic food at low prices, which is likely to take market share away from Whole Foods Market.
Most other grocery store chains are also adding more organic/healthy food to their shelves. Some examples include: Wegmans, Casey's General Stores (CASY) and Sprouts Farmers Market (SFM). All of this increased competition is likely to take market share away, thus leading to more comp store sales declines for Whole Foods Market.
image source: quickmeme.com
Valuation Doesn't Support Low Growth
Whole Foods is trading at 20.9X expected 2017 earnings and 20.4X expected 2018 earnings. That is high considering that EPS is expected to decline 6% in 2017 and increase 2.8% in 2018. The company's competitors are trading with lower valuations and higher expected growth. Here's how Whole Foods stacks up against the competition:
Whole Foods Kroger Casey's General Stores Sprouts Farmers Market Forward PE 20.4 14.9 18 19.9 Expected 2017 EPS Growth -6.5% 1.5% -7.5% 12% Expected 2018 EPS Growth 2.8% 7.7% 14.7% 16%
Data source: Thomson-Reuters
Whole Foods is valued closely to Sprouts Farmers Market. However, Sprouts has significantly higher expected growth than Whole Foods. Kroger and Casey's have higher expected growth with lower valuations. Therefore, I think Whole Foods should be trading with a lower valuation. Whole Foods should be trading with a forward PE closer to or even lower than Kroger's valuation. Whole Foods is expected to average -1.85% EPS decline over two years. Whole Foods would need high single-digit or double-digit EPS growth to support a PE over 20. Therefore, the forward PE of over 20 should be at least 25% lower, more in-line with Kroger's valuation.
Whole Foods' stock is breaking down below the 200-day moving average. The 20-day fell below the 50-day moving average. This is likely to trigger more selling among some of the large shareholders, putting negative pressure on the stock price.
Risks to Investment Thesis
Whole Foods does pay a dividend which yields 1.85%. So, many investors may hold on to the stock, hoping that the company will turn around while they collect the dividend.
Whole Foods Market's new store concept, known as 365, could be successful and help turn the company around. The 365 stores have lower prices and are smaller than the standard Whole Foods stores. This is the company's response to low-priced competitors such as Aldi.
Conclusion
Increased competition for organic/healthy food is likely to continue from most grocery providers. It will take many years for the 365 store concept to grow large enough to lead to comp store sales increases for Whole Foods. The increased competition will lead to lower margins, thus hurting profitability.
Given the increased competition, I think the comp store sales declines will continue for Whole Foods Market over the next two years. As the comp store sales declines continue, the stock is likely to decline further. I expect the forward PE of 20 to drop to about 15 over the next year. The forward PE - 15X expected EPS of $1.45 for 2017 - would bring the price down to about $22. This represents a 25% to 30% decline in one year.
David Zanoni
David focuses on growth & momentum stocks that are reasonably priced and likely to outperform the market over the long-term. He is a long term investor of quality stocks and uses options for strategy. David told investors to buy in March 2009 at the bottom of the financial crisis. The S&P 500 increased 367% and the Nasdaq increased 685% from 2009 through 2019. He wants to help make people money by investing in high-quality growth stocks.
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