Whole Foods Market (WFM, Financial) has witnessed some challenging times in the recent past and the stock has sharply declined by 35% for YTD15. Whole Foods Markes might be an interesting stock to consider at these levels.
I will first focus on the reasons for the stock decline and I believe that continued decline in comparable store sales is a major reason that has disappointed markets. From a high of 8.7% in comparable store sales in FY12, Whole Foods Market comparable store sales have slumped to 1.3% for the third quarter of 2015. For FY15, the company expects comparable store sales to remain in low single digit. Unless there is an effort to reverse this slide, Whole Foods Market can continue to decline.
One of the initiatives that I believe can work for Whole Foods Market is the new stores by the name of 365. The idea behind 365 is to offer smaller stores, and the company sees potential for 1,200 stores of 365 in the U.S. This idea is not entirely new, but is gaining prominence among retailers and similar format store operators in the US.
Target (TGT, Financial) has launched CityTarget and TargetExpress in 14 locations across the country. The stores aim to create a more locally relevant experience for guests in urban areas and the idea is smaller stores. Another factor that might work for Whole Foods Market is the rebranding in the name of 365. While this initiative has just been launched, I consider smaller format stores as a good strategy going forward as it will increase the company’s penetration at locations where a larger store format is not possible.
Going forward, I expect small stores to dominate in terms of number of new stores. I must add here that there is a gradual shift in the U.S. towards fresh food and organic food. Therefore, the company does have a big market to address, but competition is a challenge along with cost. The company’s recent lease for 365 stores comes at A+ real estate sites and there needs to be strong growth traction to maintain decent EBITDA margins in these real estate properties.
From a cash flow perspective, Whole Foods Market has done well with $997 million in operating cash flow for 9M15 against a capital expenditure of $680 million for the same period. With free cash flow sustaining even in challenging times for the company, share repurchase and dividends will continue to flow. However, at this point of time, investors need to keep an eye on comparable store sales. While some exposure can be considered at current levels, I would upgrade my view for a bigger exposure to the stock only if comparable store sales improve in FY16 and the 365 format stores start delivering positive results.
From a valuation perspective, Whole Foods Market is trading at FY16 PE of 18.5. Valuations are therefore not expensive after YTD15 slump in the stock. Therefore, the stock might not have much downside from these levels and some exposure is advisable.
In conclusion, Whole Foods Market is facing challenging times and the company is trying changes to overcome the challenges. The next 3-4 quarter will decide if the company’s new plans can bring a difference. With the industry outlook promising, there is strong hope that Whole Foods Market can deliver a turnaround in growth.
