Why Whole Foods Market, Inc. Is a Victim of Its Own Success

Whole Foods Market (NASDAQ: WFM  ) was the talk of the investing town last week, tumbling nearly 20% following its earnings report. Clearly, investors saw some numbers that they were not at all pleased with, although expectations for the organic supermarket chain do seem to be strung very high. Growth seems to be slowing down somewhat, largely due to increased competition in a space that once belonged almost exclusively to Whole Foods. New entrants such as Sprouts Farmers Market (NASDAQ: SFM  )  as well as increased organic offerings from established chains such as Kroger (NYSE: KR  )  are eating away at Whole Foods' business.

Source: Whole Foods Market

Slowing growth
It seems as if Whole Foods investors have become a bit spoiled over the last few years and have now punished the company hard for a somewhat predictable slowdown in growth. The stock suffered an absolutely brutal sell-off last Wednesday, down some 19% on the day and around 33% for the year. What had investors pushing the panic button?

First of all, earnings per share missed the consensus by $0.03, coming in at $0.38. This figure is flat compared to last year. Comp-store sales growth slowed to 4.5% from 6.9% a year ago, in part due to the timing of Easter this year. Revenue growth of 9.7% doesn't look too bad on the face of it but missed the consensus estimate by about $20 million. Analysts scrambled to downgrade the stock, adding to the losses.

What perhaps worried investors the most was the fact that the company lowered its guidance for the third time in the space of just a few months. In management's own words the company had been "overly optimistic" as to its growth prospects. Whole Foods now expects to earn between $1.52 and $1.56 per share versus a previous forecast of $1.58-$1.65 and a consensus estimate of $1.61. Comp-store sales estimates were also lower, now expected to be in the range of 5%-5.5% growth.

An increasingly crowded space
Whole Foods' previous success has led to two important developments. First of all, investors have gotten used to impressive growth metrics and are now throwing a tantrum when the company fails to meet these lofty expectations. Secondly, this success has led to mainstream interest and acceptance of organic foods, leading to an enormous increase in competition in the space. In the words of CEO John Mackey:

"There's a lot more competition, a lot more entrants into the marketplace as well as conventional supermarkets copying and imitating a lot of what we're doing."

Established supermarket chains as well as new, specialized organic-food markets are eating away at Whole Foods' market share. Kroger, for example, one of America's largest grocery store chains, is making an aggressive push toward marketing its "Simple Truth" line of organic offerings. Moreover, the company is remodeling some of its stores under the "Fresh Fare" brand to look more like Whole Foods locations, offering freshly prepared organic food.

Competitors like Sprouts Farmers Market aren't helping Whole Foods either, the company's success having spawned a number of comparable chains going head to head with the original. The Whole Foods report sent the industry tumbling, taking down Sprouts for nearly 12%. Investors seem to be pessimistic as to the industry's prospects, even though Sprouts posted comp-store sales growth of 12.8% for the period as well as nearly double last year's earnings before interest, taxes, depreciation, and amortization; and it reported a 26% gain in revenue. It seems as if Sprouts' strong performance could only have been at the partial expense of Whole Foods.

The bottom line
Whole Foods Market, once the unchallenged leader of the organic food space, seems to have run into a bit of a brick wall. High expectations from investors mean that any slowdown in growth crushes the stock. Its popularity has spawned a number of new competitors and has led established supermarket to up their organic game. As such, investors should be cautious as to Whole Foods' prospects, despite the fact that it is still reasonably profitable for now.

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Daniel James

I'm primarily a value and fixed-income investor with a background in cultural anthropology. As a writer for the Fool, I focus mainly on the consumer goods sector, also dabbling in technology occaisionally. When not pouring over the world's stock markets, I like to read, travel and make music.

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