Despite Whole Foods' Issues There's Still Value in the Organic Food Industry

Shares of Whole Foods Market (NASDAQ: WFM  ) have been relatively flat since their initial tumble back in May and are still down 40% from their 52-week highs. Bloomberg expects Whole Foods Market to have one of the fastest growing dividends over the next few years. It has a projected three-year dividend growth rate of nearly 20%. Its dividend yield is 1.3%, and it's the only one of the three big specialty grocers (which includes The Fresh Market  (NASDAQ: TFM  ) and Sprouts Farmers Markets  (NASDAQ: SFM  ) ) that offers a dividend. However, is that dividend enough to keep investors interested?

The industry leader
Whole Foods is the leading specialty foods retailer by far, but it's come under pressure over concerns about its growth. For its fiscal second quarter its same-store sales growth came in at 4.5%, which was below the 6.9% it churned out in the same quarter last year. It also laid out sales growth expectations for 2014 which include 10.5%-11% growth, down from its previous guidance of 11%-12%. This led to a cut in expected earnings growth from 7%-12% down to 3%-6% for the year. However, Whole Foods has laid out long-term goals; these include getting its sales to $35 billion by fiscal 2018, versus current annual revenue of just under $14 billion.

As mentioned, Bloomberg expects Whole Foods to have one of the fastest growing dividends in the market over the next few years. In addition, the company is still generating impressive levels of cash flow. During the fiscal second quarter of 2014, it brought in $282 million in operating cash flow. It spent $143 million on capital expenditures, so it had cash left over to spend $45 million on dividends and $55 million on share buybacks. Whole Foods still has nearly $670 million left under its current buyback program, which is good enough to reduce its shares outstanding by 5%.

The next best thing
The Fresh Market is one of Whole Foods' biggest competitors. While Whole Foods might be hitting a level of saturation, it appears that the likes of Fresh Market still have expansion opportunities. The company had around 150 stores as of the end of fiscal 2014, which it grew from just 50 in 2005.

Goldman Sachs recently slapped The Fresh Market with a sell rating, noting that the grocer will come under pressure from rivals and increased input costs. Thanks to this, Goldman also believes it will be hard for the major specialty grocers to meet earnings expectations for this coming quarter. This comes after The Fresh Market reported earnings in line with estimates and comparable store sales up 2.5% in its quarter that ended in April. However, it reported lower-than-expected margins.

Prior to Goldman, Morgan Stanley started coverage on The Fresh Market with an underweight rating. The investment bank noted that the grocer hasn't been effectively marketing itself as having superior quality perishables. 

The underrated player
Then there's Sprouts Farmers Markets, which has 175 stores across the Southwest. Sprouts Farmers Markets has a bit of a different business model than the other two since it focuses on produce. Its stores are set up with more informal and open designs.

Its produce sales account for a quarter of its sales, but only take up 15% of its selling square footage. The company also has a big opportunity to grow its store base. It thinks it can expand to 1,200 stores total across the US, with three quarters of these stores in new states where it doesn't currently have a presence. Sprouts Farmers Market is the cheapest of the three stocks listed on a forward P/E and P/S basis. It also has the highest return on equity.

Bottom line
All three specialty foods retailers should be winners as the economy rebounds, since the demand for for higher-priced goods will increase. Whole Foods Market has one of the best brand names in the organic foods supermarket space. It has been the hardest hit of the three in terms of stock price over the last few months. However, it's still not the cheapest. For investors who are interested in playing the organic foods space, The Fresh Market looks to be worth a closer look.

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  • Report this Comment On July 22, 2014, at 8:41 AM, Stockems wrote:

    Why do you say Sprouts is the cheapest based on forward P/E? TFM is trading at 17x forward earnings, WFM is trading at 21x forward earnings, and Sprouts is at a whopping 38x forward earnings or 2+x as expensive as TFM. Also, I'm calculating both TFM (18.23%) and WFM (14.68%) has a higher ROE than SFM (13.87%) as well.

  • Report this Comment On August 12, 2014, at 10:08 PM, TimeModeCo wrote:

    Stockems is right, I was thrown by the statement as well. GAAP earnings probably understate earning power.

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