As Dan and I were discussing Whole Foods stock this morning, he said, “Whole Foods is a freakin’ grocery store that trades at 32x next year’s earnings that are expected to grow 15%…that’s just stupid.”
I couldn’t agree more. There is a time and place for high-flying, sentimental stocks like Whole Foods, but now is not that time. The stock has been on radar ever since early fall. In October, Dan set up a bearish trade in WFM, since he felt the stock’s strong YTD performance was increasingly making the stock look “priced for perfection” in an environment where investors we shooting first and asking questions later in prior consumer-related market leaders like AAPL, SBUX, CMG, NKE & PCLN. He took the trade off for a small loss before earnings, but the thesis was correct. WFM has underperformed the SPX index by 5% since Nov 6th, primarily due to weaker earnings.
What’s the bullish argument? On Nov. 20th, GS upgraded WFM from hold to buy, with 3 main points underlying the thesis:
- Greater confidence in sustained high-single digit comp growth and square footage growth within the rapidly growing natural and organic industry
- Opportunity for EBIT margin expansion from improved sales productivity and fixed cost leverage
- An attractive entry point at 30x NTM EPS, which has been a valuation floor over the last 3 years
For argument’s sake, I’ll grant the first 2 points (though point 2 seems optimistic to me). It’s the 3rd point where I take issue. WFM grew EPS 60% in 2010, 28% in 2011, and 26% in 2012. In contrast, it’s expected to grow 15% for next year. I see little reason why the valuation floor that applied to the stock when growth was twice its current projection should offer much support.
On a technical basis, the stock also looks vulnerable, which has not been the case for most of the past 3 years. The stock has hardly ever traded below its 200 day moving average in the past 3 years:
While WFM has traded back above its 200 day breach from the last 2 weeks, today’s price action is another tell-tale sign to me that the stock is in a weak technical position. WFM announced a $2 dollar special dividend last night, and the stock opened today around $94.50, but sold off within the first hour, and is only up 0.4% as I type. When the stock has trouble rallying on good news, and is only 2.5% above its 200 day ma that has served as such strong support in this big bull run, the bear case is significantly strengthened.
We debated initiating a trade today, but our one concern is the way other stocks with special dividends have reacted into their “ex-dividend” date. WYNN rallied on its special dividend announcement, but also into its ex-dividend date, and COST seems to be doing the same thing. WFM goes ex-dividend on Dec 6th, so we might initiate our bearish trade in the first half of next week, depending on how the stock acts.