Whole Foods' (NASDAQ: WFM) latest earnings report and guidance proved the company is mortal, and disappointed investors sent the shares spiraling downward by more than 7%. Is this merely a hiccup in a great growth story, or have competitors such as The Fresh Market (NASDAQ:TFM), Sprouts Farmers Market (NASDAQ:SFM), and other traditional grocers offering natural foods caught up?

There are signs investors should get used to slower growth. However, the shares are still trading at at 35 times earnings, despite the recent pullback. This still seems rich, and the market's expectations might still be unrealistic given the increasing competition.

Results improve, but growth falters

At first blush, first quarter results do not look too bad. After all, sales grew nearly 10%, to $4.2 billion. Comparable sales increased 5.4%, and it was facing faster 7.2% comparable store growth in the same period a year ago. . However, this includes relocated and remodeled stores. Its identical store sales, which strips out these factors, was 4.8%. These might seem respectable, but it has averaged a higher 7.3% growth over the past 15 years, according to management.

Looking at the bottom line, earnings advanced 8.2%, to $158 million, and diluted earnings per share were $0.42, rising at a slower 7.7% pace. This missed the consensus estimate by 2 cents.

This could be a blip, easily blamed on weather, except management lowered its guidance for the entire year. Management now expects comparable store sales growth of 5.5% to 6.2%, versus its prior forecast of 5.5% to 7%. It also lowered diluted earning per share guidance to a range of $1.58 to $1.65, from $1.65 to $1.69. This equates to growth of 7% to 12%, versus prior expectations of 12% to 15%.

 Looking ahead, investors should keep on eye out for how much free cash flow the company generates. This fell by more than 20%, to $118 million. However, breaking down the different components, cash flow from operations rose 11.2%, to $337 million, while it spent more on developing new locations and other property and equipment. It has increased its spending on stores over the last few years, and last year's free cash flow grew only 1.7%, to $472 million.  While management hopes these investments will pay off in the future, it will be facing a field that is more crowded than it has in the past.

Competition heats up
Whole Foods has identified an attractive niche by offering natural, healthy foods. Of course, the fast growth and fat margins have not been lost on traditional grocers and upstarts. Even with the reduced guidance, operating margins are expected to be in the upper 6% to 7% range. Traditional supermarkets, such as Safeway (NYSE:SFY) have operating margins of about 1%. Of course, the food and drug retailer had essentially flat top-line growth for the first three quarters, and falling operating income. Sales were $25.8 billion, and operating income declined more than 11% to $325.5 million.

 

The natural goods retailer, which generally charges higher prices, has responded to the economic environment and competitive environment by offering its 365 Everyday Value brand. While it may be a pre-emptive move, it clearly reflects the company's recognition of the competition. In addition, offering store brands is not an innovative approach.

Sprouts Farmers Market is a smaller competitor with 160 stores in 8 states compared to Whole Foods' 373 stores, which are mostly located in the United States. However, Sprouts is growing rapidly. Led by a strong third quarter pro forma comparable store sales increase of 10.2%, diluted earnings per share jumped to $0.08 from $0.01 a year earlier. Last year's results are adjusted as if the Sunflower acquisition, which was completed May, 2012, was part of the company since the start of 2012.

Importantly, the company boosted its full-year guidance for fiscal 2013. It now expects sales growth of 20% to 21%, from 19% to 20%, and comps to increase 9% to 9.5%, from 8.5% to 9%. Management raised its guidance for adjusted diluted earnings per share to $0.45 to $0.46, from $0.41 to $0.43.

 

The Fresh Market has also been opening new stores at a nice clip, including ten in the third quarter. These are located in Alabama, California, Florida, Indiana, Kansas, Texas, and Virginia. It had 146 stores in 26 states at the end of October.

Comparable store sales increased 3.1% for the third quarter, mostly due to increased volume. Still, share net was flat, at $0.23.


Final thoughts
Whole Foods has had enviable growth. Unfortunately, that cannot go on forever. However, a P/E in the mid-30s means the stock is priced for fast growth. In other words, there is very little margin for error. Sprouts is experiencing nice growth, but investors may want to wait until the company is more seasoned. Granted, Fresh Market has a more modest P/E of 24, but its growth is not very exciting at this juncture.

Faltering growth amid increasing competition causes this investor to look elsewhere for profitable opportunities.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Lawrence Rothman has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market and 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.