Is Whole Paycheck Now Half Paycheck?

AnnaLisa is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A total pricing and promotional change is overtaking Whole Foods Market (NASDAQ: WFM) that may mean higher value for customers but lower share prices for investors. Wall Street does not like the company's strategy to cut prices as it moves forward with its master plan to open more stores to meet a goal of triple their current US store count.  Part of that plan involves a concerted move into smaller and less affluent locations. Analysts are seeing this as diminishing its high end cachet, which had led to the moniker "Whole Paycheck."

Grocery stores generally have margins so thin you can see right through them, like shavings of prosciutto. The profit margin at Safeway (NYSE: SWY) is 1.35%, and at Kroger (NYSE: KR) it's .77%. Supervalu's margin is gasping for breath at -1.38%. These make Whole Foods Market look like a retail genius with its 4.06% profit margin.

The Competitive Environment

Whole Foods had been a market darling in 2011-12, but it's barely up 5% over the last year with a recent decline from $97.00 before earnings to $84.00 on Feb. 26. Part of the reason the stock slumped is that the large grocery chains, already located in these smaller communities, have been offering plenty of the healthy alternatives and brands that Whole Foods carries as well as the service counters: the fish, meat, cheese, and bakery on-site for which Whole Foods is known. Whole Foods will have to compete with Safeway and Kroger-level prices. Of course, it's not just Safeway and Kroger; they just happen to be the largest and best-known publicly traded chains.

Whole Foods is going to be competing for that grocery dollar not only with the big chains but also with privately held grocers like Wegman's, which fosters hugely loyal shoppers who call themselves Wegmaniacs. Wegman's store openings are events that draw up to 24,000 on an opening weekend. The stores are very similar to Whole Foods with samplings and healthy food, but also the normal staples of a Safeway or Kroger. Not only that, Wegman's is rated number one in grocery satisfaction in a survery conducted by Consumer Reports, with the other competitor for the Whole Foods customer, Trader Joe's, at number two. To put this in perspective, Wegman's has only 81 stores to Whole Foods' 345. Whole Foods also has stores in Canada and England.

On the call, Whole Foods EVP David Lannon admitted that competition is increasing across the nation and that this change in price philosophy is essential. Kroger is its largest competitor with 2,354 grocery stores, 2,000 more than Whole Foods.  Kroger also operates fuel centers, convenience stores, and fine jewelry stores (for real!). Kroger has a P/E more than twice as large as Safeway's at 22.47 and a 2.00% yield. Analysts expect 9.80% five year EPS growth annually. It just hit a 52 week high of 29.57 on March 5, and the company reports again March 7.

Why Margins May Compress

Here's the comment from co-CEO Walter Robb on the earnings call that sunk Whole Foods' shares, "We intend to expand our value offerings across the store and improve our competitive price positioning. As such, we are not forecasting an improvement in gross margin this year" (from Seeking Alpha transcript). Despite Robb telling analysts in the Q&A that this strategy was an important part of gaining market share, the stock sold off 8.2% the next day on high volume.

If even Whole Foods' margins are going to be challenged and the growth slows, the supermarket sector will be a difficult place to park your shopping cart of stocks (or your green mesh bag). Whole Foods had annual growth of up to 44% over the last five years, but analysts see that being cut to 18.68% five year annual EPS growth (yoy). At its current P/E of 32.33 with a forward P/E of 25.21 and a yield of only .90%, other grocers like Safeway are reaping the bullish sentiment. Even at a 52 week high Safeway's P/E is only 10.12 with a 2.90% yield. Those are Apple-like numbers, except for the margin and the growth, of course.

After the Q1 earnings call on Feb. 13, Wells Fargo reiterated its Outperform on the stock, attributing the weakness in Q1 and Q2 same store sales numbers to the payroll tax increase. However, in my opinion the people least likely to be affected by that have traditionally been the ones shopping at Whole Foods.

Abandon Your Cart?

Any number of analysts are saying the selloff is a good entry point. Whole Foods said on the call that they've have been containing costs better and that rents in general have been lower and margins have expanded. Like Wegman's, it is a destination shopping experience. It is like the Starbucks of grocery shopping, a cool place to see and be seen. It is still one of the better stocks on any metric for socially responsible investors with the best benefits for its employees and a huge commitment to fair trade and the sustainability of its sourcing.

The stock may continue to be pressured, but as a long term buy taking advantage of the selloff in Whole Foods might not be a bad idea. Safeway isn't a bad idea either as a yield proposition, but Kroger should remain a wait-and-see to reaction after earnings.

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leglamp has no position in any stocks mentioned. The Motley Fool recommends 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!

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