Whole Foods Plunges: What Wall Street's Saying

NEW YORK (TheStreet) - Whole Foods Market WFM shares were plunging 19.5% to $38.63 after the specialty foods grocery sharply reined in expectations for the fiscal year as competition heats up, especially since Walmart (WMT) intends to be a player in the natural and organic food space.

Whole Foods shares hit an intraday 52-week-low on Wednesday of $37.31. More than 25 million shares were traded by mid-day, as investors got spooked from last night's earnings report.

Whole Foods reported second-quarter profit of $142 million, or 38 cents per share, for the 12-week period, ending April 13, below analysts' estimates. The average of 30 analysts' estimates was 41 cents a share, according to Bloomberg data.

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Sales for the quarter rose 10% to a record $3.3 billion, Whole Foods said, but once again comparable store sales growth of 4.5% slowed for the quarter compared to a 6.9% increase in last year's quarter. The company said that comps were hurt by approximately 50 basis points from the shift in the Easter holiday from the second quarter last year to the third quarter this year.

More importantly though, the Austin, Texas-based grocer slashed its annual earnings forecast, to a range of $1.52 a share to $1.56 a share from $1.58 a share to $1.65 a share, implying EPS growth for the year of just 3%-6% versus 7%-12%. Analysts estimate $1.61 per share for the year, on average.

Whole Foods now expects comparable store sales growth for its fiscal 2014 to 5-5.5% down from 5.5-6.2%. Over the long term though, Whole Foods noted that it believes that it's "growth prospects remain strong." Starting in fiscal 2015, the company's goal is to "deliver earnings per share growth equal to or in excess of sales growth." It also expects to lower gross margin to 34% to 35%.

"The company believes this level is sustainable and the right strategy to drive sales growth over the longer term," Whole Foods said in the earnings release. "At the same time, the company will continue to invest in technology while maintaining expense discipline, working to improve its cost structure to offset the impact of these investments, resulting in slight improvements in operating margin through fiscal year 2018 and beyond."

"We have a clear point of view of what we need to do to improve our value image and extend ourselves digitally to add convenience and flexibility to support our customers' busy lifestyles," said Walter Robb, co-CEO of Whole Foods Market. "As we have successfully accomplished over the last several years, we will work to improve our cost structure to offset the impact of our value and technology investments, and expect to produce year-over-year improvement in operating margin in 2015 and beyond."

"Since Q3 last year, our average price per item growth has moderated to 160 basis points from 3.3% to a three-year low of 1.7% this quarter. We attribute this primarily to our proactive value strategy and believe this is the biggest contributor to the change in our comp trends over the last several quarters," Mackey said during last night's earnings call.

"A dynamically changing competitive market is certainly a factor as well. The growing demand for fresh healthy foods, the offering of natural and organic products is expanding everywhere and new stores, existing stores and online," he added. "Looking at the big picture, that's a positive for us, as it affirms our mission for the last 36 years and speaks to the increasing growth opportunity. However, we believe it is currently impacting our transaction count growth. In addition, severe weather in several of our larger regions impacted shopping patterns again this quarter, customers making fewer trips and buying more items each trip."

Wall Street analysts retreated from Whole Food's stock on Wednesday morning. At least four analysts cut their ratings on the company: Deutsche Bank (DB) cut to "hold" from "buy," Piper Jaffray (PJC) cut to "neutral," BMO cut to "market perform" from "outperform" and Cantor Fitzgerald lowered to "sell" from "hold."

Here's what analysts were saying following the report:

Ajay Jain, Cantor Fitzgerald (Sell; lowering price target to $38 from $48)

Virtually all of the metrics in Whole Foods' latest earnings were materially worse than our expectations. We think it's appropriate that management is taking a gradual and measured approach toward price investments while providing longer-term visibility on its store development plans. However, the latest earnings report marks the sixth out of seven consecutive quarters in which guidance/earnings have resulted in significant disappointment.

Kelly Bania, BMO Capital Markets (Market Perform; lowered price target to $40 from $65)

We are downgrading WFM shares to Market Perform as we believe we have likely underestimated the nature of the accelerating competitive environment, which has resulted in a more uncertain outlook for comps (still planned ~6% long term) despite a much more bleak long-term gross margin outlook (expected to decline 25-30bps annually through fiscal 2018). Importantly, we believe a more cautious approach to WFM shares is prudent given 1) the company's plans to continue accelerating new store growth in spite of weakening comp trends (sq. footage growth expected to increase to 11% by fiscal 2018, up from 8-9% in fiscal 2013); 2) company plans to lower operating expenses by 30-40bps annually through fiscal 2018 while still investing in technology initiatives, which in our view, risks negatively impacting the customer experience and may impede the company's ability to continue innovating its differentiated in-store experience; 3) risk that a continuation of price investments may take longer than expected to result in a favorable customer response absent a more aggressive advertising & marketing approach; and 4) risk that continued product innovations (in areas such as Non- GMO, more transparent conventional produce standards, etc.) may not resonate with a broad enough subset of customers near term, which may be required to help reinvigorate comp growth in an increasingly competitive environment for WFM's core natural and organic products.

Jason DeRise, UBS (Buy; lowered price target to $48 from $70)

Unit growth explains the majority of the WFM valuation, but the limited operating leverage generated by our new comp estimate explains the significant reduction in our target price. The string of disappointments explains the significant multiple contraction to 26.6x 14FY EPS and 23.5x 15FY EPS. Until WFM can prove its comps and earnings have bottomed, investors will continue to explore more pessimistic downside scenarios. We see downside to $30, assuming 4.5% identical store sales growth, which would limit EBITDAR growth to ~8%, and imply a 20x 14FY PE. We still believe WFM's efforts will work, as reflected in our estimated reacceleration. This supports 27x 15FY EPS.

Rupesh Parikh, Oppenheimer (Outperform; lowered price target to $55 from $61)

Last night WFM reported weaker than expected Q2 (Apr.) results and trimmed full year guidance for the third quarter in a row. Sales and margins fell short of Street forecasts as management price investments had a much greater than anticipated impact. A fluid competitive environment with greater unit openings from specialty food retailers and increased competition from other grocery channels has made it more difficult to forecast near-term sales trends. With persistent revenue shortfalls from WFM and others, we believe investors are likely to take a wait-and-see approach toward the name until comp trends again stabilize and potentially reaccelerate. Shares are likely to remain range-bound near term in the low $40s. Our Outperform rating reflects our positive L-T outlook on the company's unit growth prospects.

--Written by Laurie Kulikowski in New York.

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