Hungry at Whole Foods

It's a story of growth interrupted.
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Whole Foods Market

(WFMI)

is a story of growth interrupted. Shares were down roughly 20% on heavy volume in early trading. At $48, the stock is just 2% above its 52-week low.

The grocer

reported earnings last night, and you guessed it: The numbers were awful. It couldn't have been much worse.

The company missed sales estimates for the quarter and now projects sharply lower growth in same-store sales for the year. I believe fiscal 2007 earnings may come in closer to $1.48 a share, down sharply from the consensus forecast of $1.64.

Size Slows It Down

It's getting harder for Whole Foods to grow as it gets bigger, and the company faces tough competition. Supermarkets are imitating Whole Foods by offering fresh, high-quality prepared foods and produce. Management specifically cited

Wegmans

and

Trader Joe's

as threats.

But there's every reason to expect competitors such as

Wal-Mart

(WMT) - Get Report

,

Safeway

(SWY)

and

Kroger

(KR) - Get Report

to imitate the success of Whole Foods.

Finally, cannibalization is also a problem, as new stores hurt sales at existing stores.

Unfortunately, these don't sound like short-term challenges.

'Whole Paycheck'?

In addition, image is another problem. It's expensive to shop at Whole Foods, and some folks have nicknamed it "Whole Paycheck." That's a tough image to shed.

On the bright side, the company generates lots of cash. Whole Foods is using the money to expand its square footage by more than 10% a year, and existing stores are still showing comp-sales growth of 6% to 8%.

I would estimate that this stock deserves a price-to-earnings ratio of about 25 times. That yields a price target of just $37, which is well below the current price. I wouldn't be interested in Whole Foods until it drops below $40, so I'm staying on the sidelines.

To watch a video version of Whole Foods' earnings review, please click here.

At the time of publication, Bagley had no positions in any stocks mentioned in this column, although holdings can change at any time.

Jeffrey Bagley, CFA, is a portfolio manager for McCabe Capital Managers, Ltd. Bagley received a master's of business administration in finance from Fordham University and a bachelor's of science in business economics from the State University of New York at Oneonta. Disclosed holdings may change at any time without notice. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. Bagley appreciates your feedback;

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