New Trade $WFM – On The Whole This Looks Like A Good Press

by Dan April 1, 2013 3:02 pm • Commentary

WFM is down 6% year-to-date in 2013, a large under-performance relative to the broader market, which is up around 10%.  The obvious catalyst was a weak Q4 earnings report in February, that saw the stock gap down below 90 and never recover.

Prior to that earnings report, we published an Earnings Preview, in which Enis summarized the fundamental backdrop as follows:  

WFM has impressive secular tailwinds at its back, as the health / organic foods market continues to show strong growth in the U.S. (97% of company revenues are from the U.S.).  The following table, from the company’s most recent quarterly release, shows same store sales growth over the past 15 years:

Screen Shot 2013-02-13 at 1.51.25 PM

Consistent performance for such a long period.  Whole Foods is the rare supermarket with brand value as well as good execution, as it spends almost no money on advertising but attracts an affluent customer base.

However, as usual with a trendy company, valuation is a concern.  Here is the 5 year chart of the P/E:

5 year chart of WFM P/E, Courtesy of Bloomberg

5 year chart of WFM P/E, Courtesy of Bloomberg

The company is projected to grow earnings 15-20% over the next 2 years, which is commendable growth, but worth paying 35x for it?  Seems on the rich side compared to other stocks in this market.

The identical store sales growth for the most recent quarter was 7.1%, near the low end of its 15 year range.  More importantly, here is what management said about the next 3 quarters:

As reflected in this outlook, the Company does not expect to produce the same level of diluted earnings per share growth over the remainder of the year as it produced in the first quarter of fiscal year 2013 due primarily to tougher gross margin comparisons, particularly in the second and third quarters of fiscal year 2012, along with its ongoing strategy to expand value offerings across the store and improve its competitive price positioning. As such, the Company does not expect an improvement in gross margin this year, and given results for the sixteen weeks ended January 20, 2013, this implies lower year-over-year gross margin for the remainder of the fiscal year.

Clearly, this is a stock that has lost earnings momentum.  Management is telling you as much.  Valuation has come down a bit after earnings, but it’s still a 30 P/E name, only expecting to grow earnings 10% this year.

Meanwhile, the long-term technical picture looks increasingly risky.  Here is the 5 year chart:

[caption id="attachment_24273" align="alignnone" width="629"]5 year weekly chart of WFM, Courtesy of Bloomberg 5 year weekly chart of WFM, Courtesy of Bloomberg[/caption]

The stock has broken its long-term uptrend, and its volume the week of earnings was its largest since 2010 (lower panel, circled in red).

WFM’s next earnings report is in early May.  May options capture the event, but the implied vol in May is quite cheap on a historical basis.  The 60 day IV (yellow) vs. 60 day RV (blue) chart over the last 2 years, Courtesy of LiveVolPro:

Screen Shot 2013-04-01 at 2.30.37 PM


At this low level vs. history, and with earnings captured in May, we elected a structure that is long May options:

TRADE: WFM ($85.40) Bought May 83 / 78 Put Spread for 1.30

-Bought 1 May 83 Put for 2.20

-Sold 1 May 78 Put at .90

Break-Even on May Expiration:

-Profits of up to 3.70 btwn 81.70 and 78, Max Profit of 3.70 at 78 or below

-Losses between of up to 1.30 btwn 81.70 and 83, Max Loss of 1.30 at 83 or above

Trade Rationale:  WFM could set up to be the classic press on the short side of a  high valuation/high growth stock who’s earnings are decelerating and will see a dramatic re-rating on future disappointments.  This is the sort of trade that makes sense to express with defined risk given its once cult status.