The plunge in Whole Foods (WFM) shares in response to a nasty earnings miss sent a resounding message: Do not buy the stock on the premise the selloff is overdone.
Indeed not only is the selloff justified, an argument could be made that more selling is warranted (which is saying a ton given the stock's nosedive this year). Keep in mind that Whole Foods shares continue to trade at premiums to the broader retail industry. That type of valuation gap was warranted for years as Whole Foods pioneered the art of upselling customers to fancy organic food from Kraft packaged cheese and Heinz ketchup. Now, however, Whole Foods' performance trends over the past year warrant further valuation compression because, in all likelihood, profit margins have not bottomed. In fact, I am starting to wonder if Whole Foods shares should not trade closer to Target (TGT) on a price to earnings multiple basis. (Target is part of TheStreet's Action Alerts PLUS portfolio.)
And the odd thing amid all of this hoopla? Whole Foods execs may not get the ruthless environment that has surrounded the company's one impenetrable business model. I don't believe the company is moving quickly enough to lower prices, rebuild lapsed consumer trust and more profitably run its enterprise.
Here is what I saw in the results and commentary that should frighten tire kickers:
Same-store sales: I don't care what BS retail sector execs feed you on how ROIC and other less-used performance metrics are more important than same-stores -- it's a bald-faced lie. Given the costs and expenses associated with running a retail network, and growing it over time, it's essential that same-store sales increase from established locations. Moreover, growing same-stores is not enough -- the sales must be of high quality, which reflects the retailer is selling stuff people really want and are willing to buy at or close to full price.
As it pertains to Whole Foods, same-store sales fell 0.2% in the most recent quarter, a continuation of an ugly start to the three-month period. Same-store sales have declined at a quicker rate in the first few weeks of the current quarter to the tune of 2.1%. Ooof. Same-store sales are going completely in the opposite direction that Whole Foods execs have thought would happen amid efforts to lower prices and improve marketing. So the company will have to become even more aggressive on product pricing and invest more to regain customers who still do not trust the brand is charging fair prices. That will lead to low-quality same-store sales, and create risk to the margin and EPS outlooks Whole Foods shared for the next 12 months on Wednesday.
BTW, Whole Foods noted sales were below their expectations, which were likely lowered coming into the quarter. Not good.
Store openings: As I wrote on Wednesday, Whole Foods has to slow down its runaway expansion. The financial performance of the company suggests the business model being applied to each new store is wrong, and must change for the long-term health of the business. The management team has to solve the new conundrum on how to compete with greater threats in organic grocery retailing. Unfortunately, Whole Foods basically did the opposite in the most recent quarter -- it continued to open stores with reckless abandon, and projected a continued hearty pace of openings going forward. I think execs who continue to wear blinders on how capital is allocated are a major problem, and one I outlined in Wednesday's piece as being an overhang to the stock.
Speaking of capital allocation...
New share buyback: Let it be known that I have never been keen on stock buybacks. I think they only enrich the pockets of already well-paid executives instead of creating true long-term value. Nevertheless, the first take on Whole Foods announcing a new $1 billion buyback is that it's a sign the stock is badly undervalued. Not sure if that is remotely near the case, given the weakening fundamentals of the business. To top it all off, as the fundamentals are weakening, Whole Foods wants to fund this new epic buyback with $1 billion in debt. Sluggish profits, more interest expense -- not exactly easy to digest. The fact the stock plunged in the face of such an ambitious buyback suggests the market does not believe it's the right use of capital, nor that the stock is presently undervalued.
In the end, the stock's decline is a knock on the management team's credibility in steering Whole Foods back into smoother waters. I believe in the first part of 2016 we may see activist involvement on Whole Foods -- the company is being run like a private entity in public markets that are watching the company's business come under siege. Something has to be fixed here.
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