Is Whole Foods Market Still a Good Buy?

Intense competition has led to a drop in Whole Foods’ performance this year. Is this an opportunity, or a negative sign?

Apr 18, 2014 at 9:00AM

Natural and organic food retailer Whole Foods Market (NASDAQ:WFM) has been disappointing this year, as shares are down almost 16%. Moreover, the company failed to impress the Street with its first-quarter results released in February. Whole Foods' revenue and earnings came in below consensus estimates. Also, the company lowered its 2014 sales and profit forecast for the second time this year.

The company had to lower prices to attract more customers as it faces tough competition from Kroger (NYSE:KR), which is looking to make the most of the natural and organic  food market. In addition, the fact that Wal-Mart Stores (NYSE:WMT) is now looking to enter this space is another concerning factor for Whole Foods. So, will Whole Foods be able to turn its fortunes around, or is the stock no longer a good investment? Let's find out.

Trying to bounce back
As Whole Foods co-CEO Walter Robb put it, "We are not immune to the larger macro environment[,] and severe winter weather across much of the U.S. affected the shopping patterns." But, the company is working hard to increase its revenue and profitability going forward. It opened 10 new stores last quarter and now has a store base of 373. In the process, Whole Foods increased its square footage by 8% to 14.2 million square feet.

In addition, Whole Foods has been focusing on improving its price competitiveness within the grocery department, and it is now implementing this strategy in perishable goods as well. The company is looking to differentiate itself from peers by maintaining high-quality standards and broadening its product portfolio. In-line with this strategy, Whole Foods added more high-grade conventional offerings to complement its organic offerings, providing customers with a broader range of choices.

It is also working on its pricing strategy, as it faces tough competition from Kroger and other competitors. According to management, Whole Foods improved its pricing position in the most recent quarter across different areas including known value items, non-perishables, and perishables. Competitive pricing will impact sales and the gross margin in the short term. But Whole Foods believes that these short-term pains will benefit both customers and shareholders in the long run. 

Expansion strategy
On the expansion front, Whole Foods has adopted an economic value added, or EVA, approach for site selection. This gives it a wide range of markets to choose from, ranging from Memphis, TN to the New York borough of Brooklyn, to grow its business. Whole Foods believes that although productivity and expenses may vary from one market to another, appropriate capital investment will yield healthy returns for its shareholders. Whole Foods also bought seven Dominick's grocery-store leases in the Chicago area from Safeway, further extending its market position. 

The company is moving aggressively to take advantage of the growth potential of the organic food market. It anticipates that in 2017, it will cross the 500-store mark; in the long run, it sees demand for 1,200 Whole Foods Market stores in the U.S. alone. 

Competitive threats
However, Whole Foods won't find growth easily. Wal-Mart has set its sights on the organic food segment and has partnered with Wild Oats. Wal-Mart is looking to make organic food more accessible by selling Wild Oats-branded organic food at non-organic prices. Through Wild Oats, Wal-Mart will be selling products such as salsa, organic olive oil, canned black beans, and tomato paste. This move by Wal-Mart may lead to more intense competition in the organic food industry, hurting Whole Foods' prospects further.

Kroger, on the other hand, has been strengthening its organic food department since last year. Kroger had entered into an agreement with product-incubation company L.A. Libations, according to BevNET, to focus on the organic-beverage category. In addition, Kroger is far bigger than Whole Foods, with a store count of around 2,640. Hence, Kroger is capable of reaching organic food customers faster than Whole Foods due to its strong network.

Bottom line
Whole Foods is expensive at a trailing P/E of 33, while the industry average P/E ratio is just 14. Although the company is working hard to improve its sales and profitability through expansion plans, price wars and bigger competitors could throw it off track. In addition, the reduction of earnings guidance twice this year is not a good sign. So, investors would be better off staying away from Whole Foods Market.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Meetu Anand has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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