Whole Foods Continues to Be Weak

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About two months ago, I wrote an article explaining why I felt that Whole Foods (NASDAQ:WFM) had further to fall. Since then, the S&P 500 is up slightly, while Whole Foods is down about 5 percent.

I continue to be bearish on Whole Foods. The stock is acting very poorly in what has been a relatively strong environment for stocks. Even on Tuesday — a day during which we saw strength come back in the growth stocks that lost their leadership role in the past couple of weeks — Whole Foods was unable to rise with the likes of Visa (NYSE:V) or Google (NASDAQ:GOOG). In fact, the stock fell 1.2 percent to $48.90, and it traded as low as $48.16 — a new low for the year, and the lowest level since early last May.

The stock is falling for a number of reasons. First, it rose too far too fast. Shares went from a split adjusted $4 trough in 2009 to a peak of $65 just last year. At $48.90, they are still up more than 12 fold. There are a lot of people with a lot of profits in Whole Foods shares, and now that the market is getting a little jittery, they want to take their profits.

Second, the stock still trades at a lofty valuation. Analysts expect the company to earn $1.62 per share this year, which means that the stock trades at over 30 times 2014 earnings. This is implying a fairly rapid growth rate. But actually, this $1.62 is only 8 percent higher than 2013 earnings, and 8 percent growth doesn’t justify paying 30 times earnings for a stock.

The reason that analysts are bullish is that they think earnings will grow even faster — at 18 percent per year — in 2015. Even so, that doesn’t necessarily make Whole Foods’ stock compelling at the current valuation. There are other opportunities that look better. For instance, Visa is going to grow at about the same rate in both 2014 and 2015, yet that stock trades at just 22 times earnings.

Third, the grocery business is incredibly competitive. While Whole Foods is a leader in the sector, there are a lot of grocery stores that offer the same kinds of products to consumers. Furthermore, we are learning now that companies such as Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are going to begin to carry organic foods. While I don’t see the Whole Foods demographic immediately rushing over to Wal-Mart to save a little money on organic food, it doesn’t take a lot of defectors to hit Whole Food’s business.

Given point number three, point number two stands out even more. Because of the competitive nature of the grocery business, it would seem logical that Whole Foods should trade at a discount, or at a premium, to companies growing at a similar rate.

As a result of these points, I think there is still more downside in Whole Foods. As I have mentioned, we have seen extremely weak price action in the stock, and shares currently sit at an 11-month low. There seems to be some technical support in the low- to mid-$40 range, but still I think there isn’t enough value at that level — considering that the company will earn just $1.62 per share in 2014 — to justify taking a position except if you are a short-term trader looking for a bounce.

I don’t think the stock starts to become interesting until we are trading at about 20 times earnings, which means the stock can lose another 33 percent of its value. Or maybe it won’t fall that far: Maybe it will grow into a higher valuation with the stock going nowhere for a couple of years.

But given that there is a lot of disconcerting price action in growth stocks, I wouldn’t be surprised to see this continue to impact trading in Whole Foods’ stock. Investors should therefore consider taking profits on any strength. More aggressive investors might consider selling Whole Foods’ shares short and buying a cheaper and less vulnerable growth stock against this position (e.g., Visa).

Disclosure: Ben Kramer-Miller has no position in Whole Foods. He is long Visa.

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