Ignore Investors' Whole Foods Panic Attack

Whole Foods Market's (NASDAQ: WFM  ) quarterly results drove a stock price scramble downward last week. Wild theories about the organic grocer's long-term health circulated in financial headlines, and obviously spooked many investors.

Could the organic food market be reaching its saturation point? Is increasing competition from chains like Trader Joe's and Sprouts Farmers Market (NASDAQ: SFM  ) giving Whole Foods a mighty and permanent whack? Whole Foods' comps growth slowed... could it be... forever?

These are the kinds of thoughts that reflected a panicked attitude toward the organic grocer.

Competition and cannibalization
Investors seem to be particularly concerned about Whole Foods' admission that cannibalization and competition have slowed the company's current growth in same-store sales, an important piece of data in retail analysis.

However, Whole Foods has also been making pricing adjustments in order to compete more nimbly with rivals. In the quarterly conference call, management said price matches "significantly closed the gap against a major competitor." If there's increased competition, Whole Foods is on the move. Incidentally, while Trader Joe's is a major competitor, it's been around for a long while and hasn't exactly curtailed Whole Foods' growth in a significant way.

The fretting is ridiculous when one thinks about the quarter and the long term. Whole Foods' same-store sales increased by 5.9%, which is extremely high compared to the types of comps conventional grocers tend to report. On a two-year basis, comps increased by 14.5%. As has long been the case, Whole Foods' profit margins are among the highest in the business, which is renowned for skimpy margins.

Competition spooks investors
Many investors viewed recent IPO Sprouts Farmers Market as a major contender, reaching its tendrils into Whole Foods' business. However, Sprouts just doesn't appear to have the kind of true innovation necessary in the organic and natural food space. Is it disrupting anything in a big way? It's a factor to ponder.

Sprouts' stock surged right out of the gate when it started trading in August. The Phoenix-based chain last week also reported a positive quarterly earnings report that beat analysts' expectations.

However, in a sour aside, insiders are offering 22.5 million shares for sale. IPOs can often be more lucrative for insiders and institutional investors who sell after a post-IPO surge. Although cashing out some shares proves that insiders do desire cash, there's also the argument that it doesn't necessarily lend a great feeling of confidence for regular investors who jumped on immediately after a particularly euphoric IPO.

Sprouts' IPO filing didn't exactly indicate a business with huge differentiation. Is it really competing on forward-looking environmental and social measures? Simply offering organic and natural foods at lower prices may steal some business from Whole Foods. However, it will probably poach more from conventional grocers like Safeway (UNKNOWN: SWY.DL  )  and Kroger, both of which have tried to add organic sections to stores, but still haven't nailed the true soul of more socially conscious eating.

Major disruptive differentiation
Although increasing numbers of grocers are entering the organic and natural space -- including conventional stores that are gussying up their product offerings and shelving more organic and gourmet merchandise -- Whole Foods does different things with its business that will be extremely difficult to replicate.

For example, the grocer has sustainability and animal welfare labeling systems on seafood and meats. This time next year, it plans to roll out a three-tier ratings system for fresh produce and flowers. The system will measure sustainability techniques related to aspects like pest management, worker welfare, water management and conservation, pollinator protection, and other environmental and social factors.

Although Whole Foods' management indicated problems with some degree of cannibalization, one might ponder how differentiated stores make sense in some larger markets. While the company opened six stores in the Boston area, its Lynnfield, Mass., location includes a variety of distinct elements that should blow rivals' minds -- and investors' minds, too. The store has a rooftop farm -- think hyper-local produce. Its cafe is made out of six reused shipping containers, and the store has several other interesting elements shoppers would be hard pressed to find elsewhere.

Some people just don't get it
Analysts may not think innovative moves like these are important, but they have everything to do with what makes Whole Foods different from competitors that offer organic products. Those competitors generally offer the goods but not the soul. These elements represent a company that is rethinking the way the grocery business works.

Whole Foods has a reputation for being an expensive stock, and any current perception that its growth is going to be seriously curtailed underlines that fear and can cause major volatility and pessimism.

Still, compare its price to that of Sprouts, which is trading at 81 times forward earnings and has a PEG ratio of 3.42. Whole Foods is trading at 29 times forward earnings and has a PEG ratio of 1.91.

Conventional grocers' shares look less expensive; for example, Safeway has a PEG ratio of 1.25. However, the fact that Safeway is a mature company and its shares trade at 19 times forward earnings does not sound like a bargain given the fact that the chain is feeling the pinch from the top tier of grocers and the rock-bottom cheap contenders. Safeway's stock price has been on a roll, but that has nothing to do with fundamentals. It has to do with hopes for a buyout.

Whole Foods is making all the right moves to keep its business fresh and ahead of the game. Initiatives that might flummox many investors and analysts are about growth, not a stock that's soured. Events like this latest drop add up to good opportunities to get cheaper prices on high-quality stocks.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 12, 2013, at 6:14 PM, piggy60 wrote:

    As has been typical of many of David's recommendations that I have bought, the stock tanks within the month. However, I have found that these picks also usually rebound and continue going up! So too with WFM. Disappointing is that this was a "buy now," and I think TMF MUST do a better job being more in tune with upcoming earnings reports before telling Fools to buy. I think a little probing may have uncovered the "truth" about the report, and the recommendation could have been tabled for a month. Perhaps the best rule is that if earnings are close, wait until they are released before buying. I own WFM @ about $63, and I'll keep it for years to come.

  • Report this Comment On November 15, 2013, at 11:48 AM, SkepikI wrote:

    We call them "Whole Paycheck" here in NW Foodies paradise. They have much more competition than you let on Alyce, at least here. Besides TJ's there is New Seasons, at least 4 local Farmer's markets (nearly year round) and a brand new national competitor Natural Grocers. In the works, local mini market fresh organic grocer, Green Zebra. WFM investors ought to be wary.

    Their stores are beautiful, but overpriced by at least 10% across the board.

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9/29/2016 1:11 PM
WFM $28.07 Down -0.22 -0.76%
Whole Foods Market CAPS Rating: ****
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Sprouts Farmers Ma… CAPS Rating: ***
SWY.DL $0.00 Down +0.00 +0.00%
Safeway CAPS Rating: **