A Price Cut You Don't Want to Miss
Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since its most recent earnings report, shares of Whole Foods Market (NASDAQ: WFM) have fallen to trade near the bottom of their 52-week range. Fears that lower projected top lines and margins will inevitably cut into earnings growth gave Wall Street enough of an excuse for a big sell-off.
Despite a recent focus on lowering prices, I don’t think this is the kind of price cut management envisioned for its investors. Yet, for stock shoppers with a healthy appetite, now is a great opportunity to invest a whole paycheck (or more) in Whole Foods.
A big part of the Wall Street panic came from management’s reiteration that they will continue to focus on price and providing value to the customer. However, given Whole Foods has some of the highest prices in the industry as well as some of the highest margins, the huge drop in share price seems like a bit of an overreaction.
The grocery industry is filled with companies producing significantly thinner margins. As food prices rise, those margins continue to decline as grocers compete to keep customers happy. Grocery giant Kroger (NYSE: KR) is a great example as its seen gross margin decline from 23.2% in 2009 to 20.9% in 2011 and 20.3% in its most recent quarterly report.
Comparatively, over roughly the same period, Whole Foods actually grew margins from a whopping 34.8% to 35.5%. Those are some of the highest numbers in the industry, so it’s safe to say Whole Foods can definitely give customers a bit of a price break.
Why lower prices will work
Last quarter, consumers looked to cut down expenses any way they could with the looming fiscal cliff and tax hikes at the forefront of everyone’s mind. This sentiment may be to blame for the slowdown in the company’s comp sales from the usual 8.5%-8.9% to 7.2% last quarter.
We’ve seen this before. When Whole Foods faced headwinds from a dismal macro-economic environment in 2009-2010, the company cut prices and focused on costs. The results speak for themselves, as Whole Foods has seen its profits and stock price grow significantly in the years since.
Now, in another volatile economy, with higher payroll taxes and consumers looking to spend less, Whole Foods is poised for a redux of the strategy. Co-CEO Walter Robb explains they’re “going for the big prize, which is those folks that are not eating as healthy.”
As the pricing gap narrows, the value proposition for less healthy eaters becomes quite compelling. After all, most people know that they should eat healthier foods. Even with a rapidly growing organic foods market, Whole Foods believes it can accelerate that growth while capturing a large part of the market.
Growing sales and stores
There were a lot of great pieces of information to come out of the earnings report two weeks ago. Sales increased 14% as the company opened 10 new stores – more than any other quarter. While same store sales were down, compared to the previous four quarters, 7.2% is still one of the best numbers in the industry.
Even rapidly growing specialty grocer The Fresh Market (NASDAQ: TFM) usually sees comparable sales growth lower than Whole Foods’, and also saw a downtick in its latest quarterly report to 5.6%. The slowdown in comparable sales and a disappointing forecast led to a similar sell-off of The Fresh Market’s stock. However, whereas analysts expect The Fresh Market’s same store sales to grow at just 0%-4% rate when it reports next, Whole Foods is still expected to come in with a growth rate of 6.6%-8% for this quarter.
What’s more, Whole Foods is growing its store count at a faster pace than ever before on an absolute basis. It currently has 85 stores in development, and plans to expand its store count from 345 to 1000. The growing store count will continue to supplement the fantastic same store growth.
A long-term investment
While Whole Foods trades at a high P/E ratio compared to its peers, I believe that its price is completely justified by the excellent growth prospects the company presents. However, investors should note that like most high P/E stocks, even the slightest bit of bad news can cause the stock to tumble. That’s the time when long-term investors, who understand the company’s growth strategy, can buy shares at a discount. That time is now for those considering Whole Foods.
adamlevy 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!