Whole Foods shares are getting cheap

The retailer nicknamed 'Whole Paycheck' is trimming prices, which has hit profit margins and disappointed investors.

By MSN Money Partner Jul 28, 2014 1:20PM
Caption: A customer checks out of a Whole Foods Market in Washington, D.C.
Credit: © Andrew Councill/Bloomberg via Getty ImagesBy Michael Brush, MarketWatch

Whole Foods Market (WFM), also known as "Whole Paycheck," wants to change its nickname. And that's shaking up investors, creating a great buying opportunity in the stock.

Faced with tough competition, the famously expensive natural and organic food retailer is trimming prices, looking to tone down its moniker -- perhaps to "Less Paycheck."

The tactic has predictably hit profit margins and sales growth, sending investors to the exits. They’ve knocked the stock down 43 percent since last October to trade recently at $37.40.

But by now, the selling looks overdone, creating an opportunity for both swing traders and long-term investors. Here's why:

Still the innovative leader

Sure, declining margins and growth looks bad, but it's important to remember two key things here. First, Whole Foods Market is a powerful brand because it's done so much to build the organic food space since opening its first store in 1974.

Next, Whole Foods is a tough competitor itself, because it's got a knack for cooking up profitable new ideas, and transplanting them throughout the chain.

This kind of company culture is hard to create, and it will continue to set Whole Foods apart, believes Tim Hanson, a stock analyst with Motley Fool Independence (FOOLX), which outperforms similar funds nicely over the past five years, according to Morningstar. The fund holds Whole Foods, as a contrarian bet.

As an example, Hanson cites a partnership between the chain’s Brooklyn store, Third on 3rd, and the food producer Gotham Greens, which grows produce on the roof. The idea has been a hit with customers because Whole Foods can charge more for roof-grown greens, yet they still sell well, says Hanson.

Getting price cuts right takes time

With competitors like Sprouts Farmers Market (SFM), The Fresh Market (TFM), and Kroger (KR) pounding away on price, Whole Foods clearly had to fight back. 

Customer satisfaction slipped last year after rising steadily from 2007 to 2012, points out David VanAmburg, director of the American Customer Satisfaction Index. "I am cautious, though the data do not suggest Whole Foods is about to fall on its face, either."

Whole Foods' response -- price cutting -- is hurting sales growth now, but the key thing to remember is that getting price cuts right always takes time. It can take a while for consumers to respond and buy more. Plus it's a rolling experiment. Some price cuts don't bring a volume lift, so they have to be redeployed.

But ultimately it works. "That's what we’ve experienced in the past, co-CEO and founder John Mackey said in the company’s last conference call. "But there tends to be a lag."

Despite the sales growth slowdown, Whole Foods still posts 4.5 percent growth at stores open more than a year. And that is great performance for this sector, says Howard Davidowitz, a retail sector consultant and investment banker with Davidowitz & Associates in New York.

It tells us Whole Foods continues to take market share, since it's higher than inflation. "This is a great company, and I think it will continue to be a great company," says Davidowitz.

Morningstar analyst Ken Perkins predicts Whole Foods will post 5 percent to 6 percent annual same-store sales growth over the next decade.

Plenty of room for new stores

This may surprise you, since Whole Foods is such a high-profile brand, but it still only has 374 stores. That leaves plenty of room for new stores. Ultimately, this retailer could triple in size. The company has been rolling out 30 to 40 stores a year, and it says it will have over 500 stores in 2017.

So what’s next?

Whole Foods reports earnings after the close on July 30. Goldman Sachs analyst Stephen Grambling, who has a $43 price target, doesn't expect enough of a lift in fundamentals to move the stock up right away. 

But there's room for surprise. The reason: bad weather contributed to the sales growth hit last quarter. That's an excuse investors tend to laugh off. But if it was true, and sales get a jolt because the weather has improved, the stock could, too.

More from MarketWatch

Jul 28, 2014 5:20PM
Competition is forcing them to reduce prices? Isn't that the way things are supposed to work? They have good meat and produce, but their prices keep me out since there's a Costco right across the parking lot from them.
Jul 28, 2014 6:47PM
Everything about WF's is extremely positive except price where it falls flat on its face. They opened a store in my city last month and I had had great hopes. Fortunately, I  have several other local stores to buy organic products at which are 20-30% cheaper on average. What's worse is their cavalier attitude about displaying the "regular price", which is from another planet and "their price" which is still ridiculously overpriced. Its a great store if you have money to burn.
Jul 28, 2014 8:13PM
Ugh, I so wish I'd sold a year ago. Stupid Whole Foods.
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