WFM Fiscal Q2 Earnings Preview

by Enis May 5, 2014 11:28 am • Commentary

Event:  WFM reports its fiscal Q2 earnings tomorrow after the close.  The options market is implying a 6% move for the event, which is below both the 4 quarter average of about 7.25% and the 8 quarter average of about 7.75%.

Sentiment:  Wall Street analysts are mixed on Whole Foods, with 19 buy ratings, 15 hold ratings, and 1 sell rating.  The average 12 month price target is around $59 (down from around $64 3 months ago).  WFM is already down 14% so far in 2014, though it is still up nearly 10% over the past year.  Short interest is up to 4.5% of the float, its highest level of the past 2 years.

Options Open Interest:  Open interest slightly favors puts over calls, by a ratio of 1.1 to 1, a change from 3 months ago, when there were more calls than puts outstanding.  The 1 month average volume has also favored puts over calls by a ratio of 1.2 to 1.  The May17th 55 puts and the August 50 puts are the two lines with more than 10k of open interest.  

Price Action/Technicals:  WFM has recently broken the bull market uptrend that was in place for much of the past 5 years:

[caption id="attachment_39964" align="alignnone" width="600"]WFM weekly chart, Courtesy of Bloomberg WFM weekly chart, Courtesy of Bloomberg[/caption]

On the daily chart, WFM has not been able to get above the downward sloping 50 day moving average for almost 6 months now.  The 200 day moving average is also now downward sloping, and the key pivot level is $51, marked in red:

[caption id="attachment_39965" align="alignnone" width="600"]WFM daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg WFM daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

On the downside, the May 2013 earnings gap is $46.40.  Below that, $40 is the obvious longer-term support level.  Regardless, WFM is in a clear downtrend, and will likely take a good bit of time to base even if it is going to turn higher in the coming months.

Fundamentals/Valuation:  We wrote in last quarter’s earnings preview that WFM was a standout in the grocery sector for one big reason:

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.

However, our lack of enthusiasm for WFM shares over the past couple of years has been based on the rich valuation, not the admirable business.  The valuation has come down over the past 6 months, but at a P/E of 32x, with projected earnings growth of 10-15%, it does not look attractive as a long opportunity just yet.

Volatility:  30 day implied volatility in WFM has risen to around 35, near where it has been prior to earnings over the past couple of years:

[caption id="attachment_39966" align="alignnone" width="600"]WFM 30 day implied volatility, Courtesy of Bloomberg WFM 30 day implied volatility, Courtesy of Bloomberg[/caption]

Implied vol is likely to fall back to between 20 and 25 after the event.  WFM realized volatility has averaged around 25 for the past couple of months.

Our View:  WFM has gapped lower on each of the past 2 earnings reports, and is down around 25% over the past 6 months.  Expectations are much lower for this earnings report, with analysts projecting just 8% year-over-year earnings growth, in stark contrast to years of double digit growth over the past 5 years.

However, analysts are projecting 10-15% growth for the second half of the year, so market participants will be eying guidance quite closely.  The valuation is more reasonable than it has been for much of the past 2 years, but on an absolute basis, it is hardly attractive.

Put it all together, and we expect the stock to remain between $45 and $55 in the coming months, barring a major earnings surprise.  We are on the lookout for potential range trades that would benefit from that view.