Whole Foods Market (WFM, Financial) is the country’s largest chain of organic and natural foods supermarkets and has been successful in creating value of all kinds, thereby justifying its high prices. The company continued its story of posting positive earnings surprise for the fourth quarter in a row, registering 13.2% growth versus the year ago quarter. It beat consensus estimates to clock earnings of $0.43 per share during the second quarter of 2015.
However, since the top-line growth failed to meet the expectations of the Street, the shares tanked 11.4% during the aftermarket trading hours. Year to date it has lost around 14%, and is trading below the 20 and 200 day SMA mark, signifying negative sentiments. Let’s take a look at the recently reported second quarter 2015 results and see what it holds for long-tem investors.
Competition heating up
Whole Foods is facing real competition as more and more players start plying that organic and natural foods trade. For example, The Kroger Co. (KR, Financial), Sprouts Farmers Market, Inc. (SFM, Financial) and Walmart Stores Inc. (WMT, Financial) are stepping up their game in the natural and organic food market. This is resulting in a price war as a means of driving more traffic to stores, and Whole Foods is the first to face the heat. In addition, as traffic moves away from Whole Foods, the top-line growth is the first to take a hit.
For example, in the second quarter, analysts were expecting revenues of $3,711 million, but the grocer could only manage $3,647 million. This wasn’t a bad number as top-line registered a 9.8% year over year, but investors weren’t impressed, leading to stock being hammered. The top line growth was on the back of comps growth of 3.6% and square footage growth of 11% year over year.
Responding to challenge
Whole Foods currently operates 417 stores, including the 11 new ones added during the quarter. Moreover, it sees opportunity for 1200 stores and has plans to beach the 500 mark during fiscal 2017. For fiscal 2015, management is targeting square footage growth in the range of 9%–10% as a result of 38-42 new stores, including 5-6 relocations.
Many companies go about tweaking their business operations and advertisement campaigns to attract Millennial, or the generation Y, as they form a very important part of the demographics for many industries. Whole Foods plans to appeal to this generation by opening a separate chain aimed at them. John Mackey, co-founder and co-CEO, described it during the quarterly conference call:
Offering our industry-leading standards at value prices, this new format will feature a modern, streamlined design, innovative technology and a curated selection. It will offer convenient, transparent, and values-oriented experience geared toward millennial shoppers, while appealing to anyone looking for high quality, fresh food at great prices.
How this move pans out is yet to be seen, but critics and experts are airing certain valid views:
- Will this lead to further cannibalization of existing stores?
- If this does not succeed it will push back Whole Foods a few quarters back.
But, I am sure that the management must have done all the due diligence and taken all these views into consideration at the planning stage itself. Management agreed that there will be cannibalization, but it still considers it to be the right long-term move.
Also, the U.S. organic food market is poised to grow at a healthy CAGR of 14% from 2013 to 2018. This shows that there’s good market potential, going forward.
Looking ahead
For the full year, Whole Foods reiterated its sales growth of 9% fueled by low-to-mid single-digit year over year comps growth. Management also expects that EBITDA margin of about 9% and ROIC of over 14%.
Conclusion
Whole Foods is leaving no stone unturned to attract more customers to its stores. In one such move, the company has collaborated with Instacart, to start online delivery services. For the next five years, analysts expect the compound annual growth rate to be 13.25%. Forward P/E is expected to be 22.20 as against tailing P/E of 26. Given the market potential and the amount of hammering that the stock has taken, I feel that this still is a good long-term buy.
