Whole Foods Is Underperforming; What Should You Do?

Shares of Whole Foods (WFM) have underperformed the S&P 500 for the last two years. The company is under increasing pressure. There's nothing natural about this.

Whole Foods is down more than 13% year to date. Last week the company reported fourth-quarter fiscal 2016 results. The company posted earnings of 28 cents per share, 4 cents better than the consensus estimate. Revenue rose 1.7% to $3.5 billion. Comparable-store sales decreased 2.6%.

On the conference call afterwards, management cut guidance. The company forecast 2017 earnings of $1.42 per share vs. the $1.47 consensus. Revenue is expected to be up 2.4% to 4.5%, which works out to $16.12 billion to $16.43 billion. Comparable-store sales are expected to be in the range of negative 2% to 0%.

I found this quarter especially disappointing since Whole Foods was up against very easy comparisons with last year. Fourth-quarter comps last year were a drop of 0.2%. Store traffic dropped 150 basis points to a negative 4.2% in the fourth quarter.

With sales up just 1.7% and selling, general and administrative expenses up 1.9%, operating profit was destroyed. Operating profit fell 7.7% and was down 8.3% for the year-end. In fact, Whole Foods hasn't seen an operating profit since the third quarter of fiscal 2015.

If management didn't shrink the number of shares outstanding by 11.4%, earnings per share would have been a disaster.

Management has planned to cut over $300 million in operating expenses this fiscal year, but it might be too little too late. With store traffic down, increased price promotions and higher marketing expenses, Whole Foods has no earnings leverage.

Whole Foods' once great margin for earnings before interest, taxes, depreciation and amortization is getting crushed down to supermarket levels of 5% to 8%. Whole Foods had an EBITDA margin of 8.6% in 2016 only because the company posted a 9.6% margin in the second quarter. In the fourth quarter, EBITDA dropped to 7.9% and -- with increased price promotions to build store traffic and higher spending from the launch of the 365 store brand -- that number has to be headed much lower into the first quarter. Management's guidance implies an EBITDA margin of below 7.5%. Whole Foods is rapidly becoming like other supermarkets.

The company plans to open 30 new stores in 2017, including four new 365 stores and six relocations, but I don't think that is going to help much.

In my opinion, unless management can find a way to build traffic, fiscal 2017 estimates of $1.47 are too high.

The only things that could stop Whole Foods shares from going lower are an aggressive share buyback, an activist investor stirring up the scene, or rumors of a sale to a larger grocery chain.

I would avoid Whole Foods until the company can prove to investors that it has a solid plan to win back customers and expand operating profits.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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