On Thursday, shares of Whole Foods Market (NYSE:WFM) soared by nearly 5 percent as an analyst from Citigroup (NYSE:C) came out with a report suggesting that the stock could trade up to $48/share from yesterday’s close of $38.50/share. The analyst believes that the company can increase its sales and earnings per share at 10 percent and 12 percent, respectively.
Despite this conviction, I think investors need to question the growth assumptions put forth by Citigroup. The problem isn’t so much with the revenue growth number, but rather with the earnings per share growth number. Whole Foods has had no problem growing its sales. People in the U.S. want to buy healthy foods, and they are willing to pay a little extra for organic produce and meat products that aren’t laced with hormones and antibiotics.
The problem is that the company has had a difficult time converting sales growth into profit growth. This has been a problem over the past couple of quarters, and it has been largely responsible for the 30 percent year-to-date decline in the stock.
There are two reasons that the company is having trouble converting sales growth into profit growth. The first is rising operating costs. The company has to pay more now than it did in previous years for produce, meat, electricity, and other things. This has been a problem that has hit retailers at large, and Whole Foods hasn’t been immune. Retail companies have been forced to choose between raising prices and risk losing business, or not raising prices and seeing margin compression.
Whole Foods has clearly raised its prices for some things but this has not been enough to overcome rising costs. As a result, the company’s margins have compressed. In fact, in the most recent quarter the company reported roughly 10 percent sales growth but flat profits — a clear example of the problem at hand.