Whole Foods – This Is a Grocery Store, Right?

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

Call me a skeptic, but I'm not sold on Whole Foods Market (NASDAQ: WFM) the way the stock market is. The company operates about 300 grocery stores that specialize in organic and natural foods. My recurring question is, isn't this ultimately a grocery store? There are competitor grocery stores by the thousands, so what makes Whole Foods different? Does this difference mean enough to justify Whole Foods' current price? Taking a look at what is expected of the company, we find the following:

Current Price: $74.89
P/E based on '12 earnings: 32.99
Growth Expected: 18.29%
PEG: 1.80
Yield: 0.70% 

At first glance I would say the stock is expensive based on a 1.80 forward PEG ratio. However, we know that stock prices don't exist in a vacuum so maybe there has been a run-up in other grocers. Let's check two others, Kroger (NYSE: KR) and Safeway (NYSE: SWY), to find out:


Current Price: $24.30
P/E based on '12 earnings: 10.95
Growth expected: 10.71%
PEG: 1.02
Yield: 1.89% 


Current Price: $22.56
P/E based on '12 earnings: 12.33
Growth expected: 8.51%
PEG: 1.45
Yield: 2.57% 

So the average PEG of these two grocers is 1.24. Given that Whole Foods is at 1.80 it's definitely trading at a premium to its competition. Is this premium justified?

<table> <tbody> <tr> <td> <p>Name</p> </td> <td> <p>Past Growth Rate</p> </td> <td> <p>Beat Estimates By</p> </td> <td> <p>Stores</p> </td> </tr> <tr> <td> <p>Whole Foods</p> </td> <td> <p>13.42%</p> </td> <td> <p>7.1% on average</p> </td> <td> <p>316</p> </td> </tr> <tr> <td> <p>Kroger</p> </td> <td> <p>0.13%</p> </td> <td> <p>6% on average</p> </td> <td> <p>2,460</p> </td> </tr> <tr> <td> <p>Safeway</p> </td> <td> <p>-6.39%</p> </td> <td> <p>5.875% on average</p> </td> <td> <p>1,881 </p> </td> </tr> </tbody> </table>

The growth rate of a grocer appears to slow significantly once the company reaches somewhere around 2,000 stores. This is good news for Whole Foods as clearly it will be a while before they reach this point. Whole Foods expects to open between 24 and 27 stores in 2012, which is 7.6 to 8.5% store growth. The company also expects same store sales growth around 8%. This gives us a combined growth rate of 15.6% to 16.5%.

The company gave us three things to be concerned about going forward in their last quarterly earnings report. The company expects a higher tax rate, more shares outstanding, and higher capital expenditures in 2012. In the company's own words, they expect full year '12 earnings of between $2.21 and $2.26. This is right about what analysts are expecting and translates to 15% to 17% growth in earnings.

Looking at all of these numbers I can't help but think unless Whole Foods is going to open more than the 24 to 27 stores they are targeting there is a possibility of an earnings disappointment in 2012. With top line growth of 15.6% to 16.5% and the stock valued as though earnings are going to grow at 30%+ there isn't much room for error.

I know Whole Foods is small, but their growth plans don't seem aggressive enough to match the expectation of the stock.

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