$WFM Fiscal Q1 Earnings Preview

by Enis February 12, 2014 7:52 am • Commentary

Event:  WFM reports its fiscal Q1 earnings today after the close.  The options market is implying a 6.5% move for the event, which is below both the 4 quarter average of about 8% and the 8 quarter average of about 7.75%.

Sentiment:  Wall Street analysts are mixed on Whole Foods, with 18 buy ratings, 13 hold ratings, and 1 sell rating.  The average 12 month price target is $64.  The stock has appreciated 15.5% over the past year, but is down 5% to start 2014 (and down almost 20% vs. its all-time high set in October, prior to a weak earnings report).  Short interest is around 3% of float, vs. about 1.5% of float a year ago.

Options Open Interest:  Open interest slightly favors calls, by a ratio of about 1.25 to 1.  The past month’s average options volume has seen more calls trade as well, by a ratio of 1.65 to 1.  There are only 2 strikes with around 10k of open interest – the Feb22nd 55 calls, and the Mar22nd 55 puts.  

Price Action/Technicals:  On a longer-term basis, WFM has been in a consistent uptrend ever since the start of the bull market in early 2009.  Both the 50 week and 100 week moving averages have been upward sloping the entire time, and the stock recently bounced at the 100 week moving average:

[caption id="attachment_36189" align="alignnone" width="600"]WFM weekly chart, 50 week ma in pink, 100 week ma in green, Courtesy of Bloomberg WFM weekly chart, 50 week ma in pink, 100 week ma in green, Courtesy of Bloomberg[/caption]

On the daily chart, we can see the importance of the $50 support level (green line below), which has held ever since the stock’s gap higher in May 2013:

[caption id="attachment_36190" align="alignnone" width="600"]WFM daily, Courtesy of Bloomberg WFM daily, Courtesy of Bloomberg[/caption]

Whole Foods broke through the important $55 level yesterday (red line), a positive sign for a stock that has been in a downtrend since late October.  The $55 -$57 area served as resistance in July and August, and support in November and December, so it’s a short-term pivot area.  WFM’s reaction to earnings at this important pivot area will likely determine the stock’s direction in the coming months.  

Fundamentals/Valuation:  Whole Foods has reinvented the grocery store sector, and in the process, it has become one of the most valuable grocers in America.  In fact, WFM, with only around 50k employees and $15 billion in annual sales, is worth more than Kroger, which has 343k employees and almost $100 billion in annual sales.

In a business notorious for thin margins, WFM stands out because of its much higher gross and operating margins.  As a result, consistent sales growth of 10-15% (which is already higher than most peers given Whole Food’s rapid growth across the U.S.) has translated into earnings growth in the 10-30% per year range, very impressive for the grocery sector.

At the end of the day, most supermarkets are simply a conduit for other companies’ products to get to consumers.  Whole Foods has done an admirable job of developing its own internal brands, however, and like COST, has garnered a much larger share of industry profits as a result.

However, as has been our beef with WFM for much of the past 2 years, the valuation prices in a lot of optimism.  At a trailing 12 month P/E of 37x, doubling its profits over the next 4 years would only cut the valuation down to 18.5x, on a larger base from which earnings growth might slow.

The risk/reward for owning the shares here does not seem attractive as a result.

Volatility:  WFM is one of those stocks where its own earnings event trumps all other potential sources of volatility.  As a result, we can see the consistency of its implied volatility chart heading into earnings and then after the event:


[caption id="attachment_36191" align="alignnone" width="600"]WFM 30 day implied volatility, Courtesy of LiveVolPro WFM 30 day implied volatility, Courtesy of LiveVolPro[/caption]

 Given its prior history, WFM implied volatility is likely to fall back to around the 20 level after the event.  Interestingly, traders are expecting a lower move on earnings this week compared to its 4 and 8 quarter averages.

Our View:  Retail has been the worst-performing sector in the market to start 2014.  Reacting to weaker comparable sales across the industry, WFM started the year off quite weak as well.  However, the stock has rallied for 6 straight days, and is now only down 3.4% year-to-date.

Given the weak macro back-drop and WFM’s valuation, we see more downside risk to the shares on the earnings event.  However, the stock is right at an important technical pivot, which is not a good setup for a new position, so we’ll probably stay away from trading this one.