Whole Foods Markets (WFM)

[DewDiligence]

Musings on WFM’s valuation and 5-year prospects:

The FY4Q15 CC last week made it clear that FY2016 (ending Sep 2016) will have flattish comparable-store sales for the fiscal year as a whole* and a slightly lower (75 basis points) operating margin than FY2015 due to selected price promotions. However, the company’s guidance for FY2016 sales and EPS are not as bad as some investors apparently think.

Specifically, FY2016 sales guidance is +3-5% YoY on square-footage growth of 7% (from 30 new stores); FY2016 EPS guidance is >=$1.55 (including a benefit of $0.05-0.07 from the share-buyback program) vs $1.34 in FY2015 (excluding charges of $0.16 for a workforce reduction and a non-cash asset writedown)—i.e. YoY EPS growth excluding non-recurring charges of about 15%.

Although WFM is borrowing $1B in order to fund the share-buyback program (#msg-118312284), WFM has always been able to fund its store-expansion program from operating cash flow—and this will continue to be true in FY2016.

My overall assessment is that, as long as WFM can continue its gradual expansion of 5-10% per year (in terms of square-footage), sales and earnings will keep increasing even if comparable-store sales were to remain at zero for an extended period (which is a very bearish view, IMO). Although WFM’s P/E ratio could fall further, the P/E has already fallen a lot, and it is no longer much different from the average retail stock in the S&P 500.

Thus, as long as WFM continues its expansion program and is able to fund it from operating cash flow, the share price is almost certain to be higher in 3-5 years, even if comparable-store sales remain weak and the P/E ratio declines a little.

On the FY4Q15 CC, CEO John Mackey emphasized that, while there is more competition than ever, there is no other grocery store that is truly similar to WFM in quality and service. I.e., lower-priced competitors such as Kroger have copied the look and feel of WFM’s stores, but they don’t sell the same quality of merchandise, by and large. I find this a pertinent distinction insofar as it implies that WFM will continue to remain differentiated from its competitors. There is no reason (IMO) to suspect that WFM’s store-expansion plan will run out of steam anytime soon.

In short, I absolutely do not think that WFM’s business model is broken. Although a recovery in the share price may be slow to take effect, I expect the share price to at least double in the next five years, and there’s a fair chance it could do considerably better than that. At the current valuation, WFM is a compelling buy.

*WFM’s comparable-sales guidance is -2% in FY1Q16; 0% in FY2Q16/FY3Q16; and +3% in FY4Q16.