NEW YORK (TheStreet) -- Shares of Whole Foods (WFM - Get Report) have gotten stale. And unless management makes some drastic changes, investors will have to stomach more losses -- that's at least until these shares, which are still expensive, trade down on more realistic expectations.
Whole Foods stock was trading at $38.79 on Monday at 11:45 a.m., up 0.7%. Shares have plummeted 33% on the year to date. But if you were one of the smart investors who acted on my sell recommendation nine months ago, you saved yourself a lot of pain. At that time, shares of Whole Foods traded around $56, or 31% higher.
What's more, the stock then commanded a price-to-earnings ratio of 40. Wall Street assumed Whole Foods, whose name became synonymous with health, would deliver infinite growth. It's an assumption many investors regret today. Here's what I said at the time:
"I'm not discounting the fact that Whole Foods is a well-run company, one that operates at a high rate of efficiency. But at the same time I'm not willing to ignore that chains such as The Fresh Market (TFM - Get Report) and Natural Grocers (NGVC) have done quite well for themselves in a relatively short period of time. Not to mention Sprouts Farmers Market (SFM) , which sprouted out of nowhere to post 24% revenue growth and strong margins."
These are still the main talking points today regarding Whole Foods. And I don't believe, despite the recent decline, that much has been changed to improve the landscape. In fact, things might have gotten worse.
Whole Foods was not available for comment. An email sent inquiring about the company's strategic positioning was not immediately returned.
The way I see it, to fight off these threats, management will have to spend more money in marketing expenses and store expansion projects. Cash flow and profits will take significant hits in the next couple of quarters. What happens to the stock as a result won't be pretty. For now, Whole Foods investors hoping for good news should instead look for shelter elsewhere. These share may not bottom until around $32.
Consider that even with Whole Foods' price-to-earnings ratio falling to a more rational level of 25, the stock remains too expensive. These shares are trading at a P/E that is 3 points higher than the industry average. Whole Foods is losing market share each quarter, but its stock commands a P/E 8 points higher Kroger (KR). That suggests that growth will eventually come back. Kroger, meanwhile, is posting the same level of revenue growth (10% year over year) as Whole Foods. And Kroger has shown meaningful margin improvement.
For Whole Foods, I have not seen any response from management suggesting they know how to increase long-term cash flow, which is what investors are betting on. And cash flow is going to be hard to come by, especially with Walmart (WMT) now having entered the natural/organic food business.
Walmart plans to offer Wild Oats organic products at a 25% discount, which will add significant pressure to Whole Foods' margins and that of others within the space, including Sprouts and Fresh Market. Walmart doesn't enter a market expecting to lose.
Whole Foods investors hate the Walmart comparison -- and I get that. But it can't be ignored. It's foolish to just brush off the idea that the world's largest retailer is now attacking your business. Whole Foods, which is known as "whole paycheck" on account of how expensive its products are, should be prepared for a price war.
More competitors mean more margin pressure. And when there's margin pressure it means less profits. When Whole Foods was alone in this space, things were different. But the company is not alone any more. And for a business that is now suffering with growth, management will have to decide how it wants to respond.
At the time of publication, the author held no position in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates WHOLE FOODS MARKET INC as a Buy with a ratings score of B-. TheStreet Ratings Team has this to say about their recommendation:
"We rate WHOLE FOODS MARKET INC (WFM) a BUY. This is driven by several positive factors, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, growth in earnings per share, increase in net income, good cash flow from operations and largely solid financial position with reasonable debt levels by most measures. We feel these strengths outweigh the fact that the company has had lackluster performance in the stock itself."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- The revenue growth came in higher than the industry average of 4.8%. Since the same quarter one year prior, revenues rose by 10.4%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
- WHOLE FOODS MARKET INC has improved earnings per share by 7.9% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, WHOLE FOODS MARKET INC increased its bottom line by earning $1.47 versus $1.26 in the prior year. This year, the market expects an improvement in earnings ($1.53 versus $1.47).
- The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and the Food & Staples Retailing industry average. The net income increased by 6.3% when compared to the same quarter one year prior, going from $142.00 million to $151.00 million.
- Net operating cash flow has slightly increased to $240.00 million or 5.26% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -13.31%.
- WFM's debt-to-equity ratio is very low at 0.02 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Although the company had a strong debt-to-equity ratio, its quick ratio of 0.89 is somewhat weak and could be cause for future problems.
- You can view the full analysis from the report here: WFM Ratings Report