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Apparently no one told investors that companies don't grow forever, and that paying a premium for slowing growth isn't a good idea. Unfortunately for Whole Foods (NASDAQ: WFM ) shareholders, the company's terrific growth is slowing down, even while the stock's multiple is expanding. The company itself is telling investors to expect less, but the stock price is ignoring this advice.
Organic growth of a different kind
The organic foods business has been growing at a rate much faster than traditional grocers. According to market research, this business is growing by around 10% annually . Most traditional grocers are expected to grow revenue by no more than 5% in the next few years. With Whole Foods reporting revenue growth of at least 12 % annually in each of the last several quarters, it seems the company is doing well.
While Whole Foods is growing, investors are paying a premium for the stock as though the company faces little competition. The truth is, not only are there organic grocers in the same business like The Fresh Market (UNKNOWN: TFM.DL ) , but everyone from traditional grocers like Kroger (NYSE: KR ) to Target (NYSE: TGT ) wants a piece of the organics business.
The Fresh Market reported annual revenue growth of 13.3 % that outpaced Whole Foods in the last quarter. While both Kroger and Target are growing revenue at around 4%, both companies have their eyes on this business. Kroger offers a "Natural Foods " section with many organic options, while Target has bigger aspirations.
Target plans to introduce the "Simply Balanced " store brand, which will provide shoppers at the chain's over 1,700 stores with more organic choices. The company knows that organics are important, and it expects to increase its organic selection 25% by 2017. With more than 75 % of Target locations offering at least an expanded grocery selection, the company offers convenience that Whole Foods' under 400 stores can't come close to matching.
The first question facing Whole Foods is can the company grow its top-line fast enough to keep investors happy? If Whole Foods shareholders are looking for strong revenue growth, they may want to consider the following.
(Source: SEC Filings)
As you can see, Whole Foods is growing but in the last four quarters the company's top-line growth has slowed sequentially. Not surprisingly, this leads us to the second question facing Whole Foods. If the company is, "gaining market share" then why is identical store sales growth declining as well? Take a look at the last several quarters, plus the company's projections for the fourth quarter of 2013.
(Source: SEC filings)
While Whole Foods is reporting strong same-store sales, it seems clear that the company is seeing a slowdown in sales growth on this basis also. Admittedly, Whole Foods same-store sales are growing faster than The Fresh Market and Kroger at just over 3%, and Target at 1.2%. However, for a retailer with a fast growth reputation, is this enough?
A shocking conclusion
If Whole Foods sold for a multiple closer to its peers, maybe the above concerns wouldn't be that big of a deal. However, Whole Foods' multiple should cause investors to ask the question, why are we paying this much?
The most direct comparison to Whole Foods is The Fresh Market. While The Fresh Market isn't growing same-store sales quite as fast, the company's overall revenue growth was superior in the most recent quarter. In addition, analysts expect the company to post nearly 20% earnings-per-share growth versus just under 19% at Whole Foods. The big difference between the two companies is their forward P/E ratios. Investors are paying over 41 times earnings for Whole Foods, compared to about 31 times earnings for The Fresh Market. It's true that Whole Foods pays a dividend, but it seems unlikely that this less than 1% yield is responsible for a multiple that is 32% higher.
Though some would argue that Kroger and Target can't be compared to Whole Foods, the valuation gap is significant. Whole Foods is expected to grow EPS at nearly double the rate of these two companies. However, Kroger and Target both yield at least double what Whole Foods yields. In addition, Whole Foods' multiple is more than 150% higher than Target, and 180% higher than Kroger.
The bottom line is that the Whole Foods growth story needs to be reexamined. The company's top line and identical store sales are slowing. Whole Foods is expecting fourth quarter EPS to increase by 7% to 11%. For investors who have become used to EPS growth in the teens and twenties, this could be the shock that causes them to sell the stock.
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