NEW YORK (TheStreet) -- Grocery superstar Whole Foods Market's (WFM) shine faded after the company reported disappointing earnings after the market closed Tuesday. The market reacted quickly, sending shares to less than $40 for the first time since July 2012.
In Jim Cramer's book Get Rich Carefully, he writes about buying shares in companies that beat estimates and raise guidance. It's a one-two punch combination that historically is very profitable. The flip-side is selling shares in companies that miss and lower their outlooks. Unfortunately for Whole Foods shareholders, more continued pressure should be anticipated.
Analysts were quick to adjust, and no less than nine adjusted their outlook and or price targets.
- Canaccord Genuity - Lowered price target from $63 to $49
- Jefferies Group - cut rating from a buy to a hold and lowered price target from $61 to $46
- Cantor Fitzgerald - lowered rating from hold to sell
- BMO Capital Markets - lowered rating from outperform to market perform
- Deutsche Bank - changed rating from buy to hold
- Sterne Agee - cut rating from buy to neutral
- Piper Jaffray - lowered rating from overweight to neutral
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Bucking the trend of downgrades, Argus views the falling share price as a buying opportunity and upgraded Whole Foods from hold to buy. Argus may prove it's the smartest analyst in the room, but investors should proceed with caution. I will explain why.
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Enter the world's largest retailer, Walmart(WMT) - Get Report and its margin-destroying expansion into organic foods. Walmart isn't Whole Foods' only problem. Safeway (SWY) , Target(TGT) - Get Report, Kmart (SHLD) , Kroger(KR) - Get Report, and almost left-for-dead SuperValue (SVU) are closing the competitive advantage gap.
About a month ago, Walmart and organic foods supplier Wild Oats announced that about half of Walmart's stores will stock 100 of Wild Oats' packaged foods on its shelves. Wal-Mart already carries more than 1,600 organic SKUs. Walmart's decision is problematic for Whole Foods for several reasons.
Organic food makes up about 4% of total U.S. food sales, placing it squarely in a niche category that other grocers can exploit, albeit especially Walmart and Target. Organic food products not only compete against other food products for shelf space, but more or less everything from aspirin to the windshield wiper fluid in Wal-Mart and Target.
Separating Safeway, SuperValue, Kroger, and Whole Foods Market from the kings of retail is how much additional floor space can be allocated toward organic foods. Growing sales and or margins will result in relatively greater space dedicated to organic foods until equilibrium is found.
In other words, outsized organic food margins will get squeezed until it's not advantageous for others to encroach further into Whole Foods' space. This is why the company lowered its guidance and will face headwinds moving forward.
That said, Whole Foods is positioned to remain the leader in the space, but what shareholders failed to realize before the earnings release is that a stock trading with a price-to-earnings ratio of more than 30 requires top- and bottom-line growth to support a rich valuation.
Using a forward P/E of 21 and $1.80 in earnings for 2015, we arrive at a stock valuation of $37.80. If you're buying Whole Foods for more than $38 this week, you're probably paying more than you need to. Whether the company can maintain a P/E more than 30% higher than its next highest valued competitor remains to be seen. As the organic sales leader enjoying fantastic consumer appeal, I believe a P/E is warranted.
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Current and prospective shareholders will want to keep the three-day rule in mind as part of the decision process to buy or sell. When a company reports disappointing earnings and guidance, it normally takes a full three days before the proverbial "last white towel is thrown in" and the overriding selling pressure recedes. That places the sweet spot for buying this dip late on Friday or Monday next week. Don't expect more than a dead-cat bounce though. Stocks typically take at least one or two quarters of solid reporting to fully recover.
If you're interested in buying at a discount, you may want to wait a few days first.
At the time of publication, Weinstein had no positions in securities mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.