Whole Foods Investors Were Warned

NEW YORK (TheStreet) - Investors in Whole Foods (WFM) are starving today for some good news. But that's not likely to come anytime soon.

I'm not going to rub it in, but back in December, I didn't win many friends for advising investors to sell the stock. At the time, the shares traded close to $56. The stock closed Wednesday at $38.93, down 30% since my recommendation.

My caution had nothing to do with Whole Foods' status as a well-run company. Instead, it was because Whole Foods had gotten too good for its own good. The company's name, which became synonymous with health and wellness, had drawn too much competition. The stock had traded on enormous growth expectations. The price-to-earnings ratio then was close to 40. The recent decline has dropped that ratio to 25.


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Although Whole Foods was a strong growth producer, it was too risky to ignore how quickly rivals such as The Fresh Market (TFM) and Natural Grocers (NGVC) had grown in a relatively short period of time. And last month, when Walmart (WMT) announced its entry in the organic foods industry, Whole Foods' expiration date drew closer.

The company's fiscal second-quarter earnings report Tuesday confirmed these fears. Earnings of $142 million, or 38 cents per share, were flat. Wall Street was looking for an 8% jump. Even though revenue was up close to 10% to $3.32 billion, it still missed estimates of $3.34 billion.

And when you consider that the growth was driven primarily by new store openings, it makes the 10% growth less impressive. That is because new stores tend to perform well because of initial excitement. That doesn't necessarily last.

Last year, Whole Foods posted 6.9% same-store sales growth. On Tuesday the second-quarter number was 4.5%, signaling that growth has slowed dramatically. And unfortunately, management didn't guide with the sort of confidence to suggest it has a solution to fix it.

Management spooked investors by cutting its 2014 forecast, which had been already lowered. That marks the third consecutive quarter of lowered guidance. Revenue is expected to increase between 10.5% and 11% on an estimated 5% to 5.5% same-store sales growth.

Recall, the prior outlook called for revenue growth of 11% to 12% on same-store sales growth of 5.5% to 6.2%. I don't believe this revision is a coincidence. It's possible management is being overly cautious. But I believe Walmart's recent interest in this growing industry has a lot to do with Whole Foods' lack of confidence.

Walmart's plan to offer Wild Oats organic products at a 25% discount will add significant pressure to Whole Foods' margins. I won't speculate to what kind of damage Walmart might do, given that management has yet to fully deploy Wild Oats. But Walmart doesn't enter markets expecting to lose.

For now, Whole Foods investors have some decisions to make. I wouldn't be in a rush to sell the stock here, given the recent decline. Averaging down will be a good strategy. But another quarter of weak sales and worsening guidance will be tough to stomach.

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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.

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