Here is an equation that does not work for me. Paying 32 times earnings for a company who, if it hits the high end of analyst estimates, will grow 9.4% this year and maybe 17% next. When you consider this company has missed the last three quarters estimates, and four of the past 6, one has to wonder what investors are thinking.
The company?
Whole Foods
Two years ago if I wanted organic foods, I had two choices, Whole Foods or the local health food store. Since Whole Foods was the low cost purveyor of those items, sales at WFMI surged and investors enjoyed a huge run in the stock. Today I can go to Sam’s Club, BJ’s Wholesale or and of my local markets and get organic food. The question now is, since I can get the same items, cheaper, at numerous other locations, why go to Whole Foods? The answer is I wouldn’t and not many other people are either as same store sales growth last quarter was non existent at .3%. Further dampening the outlook is there is no growth impetus for the company on the horizon to justify the lofty PE shares now enjoy.
In an effort to jump start sales in February they agreed to purchase the Wild Oats Markets chain that lost $16 million last year. Revitalizing this chain will not be that easy as cash on hand for WFMI has plummeted from $267 million to $46 million in the last 12 months and cash from operations has seen a steady decline during the same period. Even should they sink the money into this chain, sales growth from it will not be impressive due to the much smaller square footage at Wild Oats locations vs. Whole Foods. Simply put, investments in Wild Oats will need to be accomplished by the addition of debt without tremendous payoff, further squeezing margins.
Much like Starbuck’s, Whole Foods is a company whose best years are behind it. Competitors have encroached on its theme and the originality that made it such a fast grower is gone. Both companies are selling products that are perceived by most people as equal to their competition for higher prices. In today’s price sensitive environment, that is not a recipe for growth.
It especially does not deserve a PE over 3 times its growth rate. Current investors of Whole Foods are in for a painful lesson in growth vs. the premium investors will pay for shares
6 replies on “Don’t Pay High Prices For Declining Earnings”
WFMI’s same store sales last quarter was 6%. This is more than 18X what you state in your article.
No growth impetus? The company has 200 stores, and only few in many major markets. The company has 1 store in organically underdeveloped Europe, where demand is high and supply low. There is 15 years or more of growth here.
Your last argument on competition is the most compelling. However, Wal-Mart sells tools, grills, lawnmowers, mulch, etc – so there’s no way Home Depot could ever grow, right? 🙂
Steve,
WalMart and HD cannot sell those items for a premium the way WF does (or is still trying to)..
Transactions grew .3%. They are not gaining new customers much like Starbucks.
Sure they can still grow (i believe I said 17% next year?), paying over 30 times earnings for that growth is insane though..
Todd,
For the majority of items, I definitely agree, and margins will have to come down.
However, the selection at a Whole Foods blows away anything at Safeway or Costco. WFMI can still earn tidy margins on it’s exclusive items.
As for paying 30x earnings… Folks have been saying the same thing about Apple for the past 3 years and Starbucks for the past 10. It all depends on how long you can grow. If, like Whole Foods, you have years and years of growth opportunity, a 30x multiple today will look cheap in 2 years.
I agree with Todd’s points. But he didn’t mention all the mistakes in your article. Here are two more.
(1) You asked “why would anyone go to Whole Foods?”, quoting .3% increase in transactions as if it was evidence that the stores are empty. The stores are uniformly PACKED; that’s one reason the comps are topping out, as well as why WFM is rapidly opening new ones and buying Wild Oats: it’s hard to expand physical stores, it’s much easier and cheaper to build and buy new ones in slightly different locations.
(2) Why would WF need to put any money (beyond the purchase price) into Wild Oats? They just finished their best quarter ever. All WF needs to do is eliminate a few redundant high-level people (not the CEO or CFO, they’re already gone), tell the employees about the WF procedures, philosophy, and benefit plan, and voila, instant growth, accretive to the bottom line.
Correction: I meant to say “I agree with Steve’s comments”. Got Todd and Steve mixed up.
Steve,
thank you for the comments and reading
Yes, they have a better selection BUT, the staple items, the constant trip things potatoes, lettuce etc are widely available. That reduces trips to WF and then reason for the stagnant transaction results. If I want a specialty item, i go there, if I want everyday items, i can go anywhere.
growth, i guess i would say, if they could, why haven’t they the past two years? my opinion is that the economics of their business are deteriorating. Apple and Starbuck are still really the only ones who do what they do, WF was but now has a ton of competition.