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Whole Foods: Why Dividend Investors Need to Be Cautious


Published December 20th, 2016 by The Financial Canadian

Luxury businesses have the potential to be a strong source of investment returns. Rather than appealing to bargain-oriented consumers, they sell based on quality – and shareholders reap the rewards through high profit margins.

Whole Foods Market Inc. (WFM) is the grocery store industry’s best-known luxury brand. Known by many as “Whole Paycheck,” this company distributes high-quality foods for the health-oriented consumer – at a premium price. Whole Foods customers are willing to pay extra for healthier food.

This has translated into dividend growth for shareholders in recent years.  In fact, Whole Foods has increased its dividend for 6 consecutive years.  In 4 years (if its dividend increase trend continues) the company will become a Dividend Achiever; a select group of stocks with 10+ consecutive years of dividend increases.

You can see the list of all 273 Dividend Achievers here.

There is no certainly no guarantee that Whole Foods will increase its dividend for 4 more years.  In fact, recent results have been somewhat troubling…

This article will examine the investment prospects of Whole Foods in detail.

Business Overview

Whole Foods Market is a US-based supermarket chain that focuses on the distribution of healthy foods – those without preservatives, artificial ingredients, sweeteners, or hydrogenated fats.

The company traces its roots to humble beginnings as a small grocer called Saferway in Austin, Texas. The name was a spoof of Safeway. One of the company’s original founders, John Mackey, still plays an integral role in the company as co-CEO (soon to be full CEO due to management changes).

Soon, the company was ready to expand, first moving to Houston, Dallas, and the rest of the United States.

Fast forward to today, and Whole Foods has grown into the premier natural foods grocer in the US with a market capitalization of ~$10 billion.

The company currently has impressive operational scope.

In fiscal 2016, Whole Foods had sales of $16 billion; operated 464 stores in the US, Canada, and the United Kingdom; employed 87,000 team members; and has been ranked for 19 consecutive years in the “100 Best Companies to Work for in America” by Fortune magazine.

Growth Prospects

Historically, Whole Foods has done a tremendous job of driving business growth.

By growing both EPS and dividends per share at satisfactory rates, shareholders have received impressive total returns from investments made in Whole Foods.

Whole Foods EPS and Dividend Growth

Source: Value Line

Recent growth at Whole Foods has been less than promising.

2016 marked the first year since the financial crisis where Whole Foods demonstrated negative EPS growth. The company also failed to deliver on other key business metrics.

Most notably, same store sales have been on a negative trend, decreasing 2.6% in 4Q2016. This was composed of a 4.2% decrease in transaction volume partially offset by a 1.6% increase in average basket size.

This trend was seen throughout fiscal 2016, with sales across all comparable stores dropping by 2.5% over the one-year period.

To counteract this trend, Whole Foods has been driving revenue growth by opening more stores.

Whole Foods Store Openings

Source: Whole Foods 10-K

For obvious reasons, this is unsustainable. Whole Foods needs to focus on restoring growth to same store sales.

What is particularly troubling is that the company’s decrease in same store sales has been predominantly seen in Whole Foods’ oldest stores.

This suggests that as the luster of a new Whole Foods location wears off, consumers are more likely to shop at cheaper alternatives like Kroger (KR).

Whole Foods Same Store Sales

Source: Whole Foods Press Release (November 2, 2016)

Clearly, “new” stores (those in existence for less than 5 years) actually had positive sales growth, which was more than offset by -3.3% and -3.1% in the 11+ years and 5-11 year age categories, respectively.

Given that eventually all of Whole Foods store will be “old”, this is a worrisome trend indeed.

Whole Foods is combating this threat with the introduction of their new 365 stores.

365 is an initiative to brings Whole Foods health-focused products to a more cost-focused market. The company has been opening smaller stores labelled as “365 by Whole Foods” that sell products on a lower price scale than the parent company’s flagship locations.

The concept was announced in May 2015 and is led by Jeff Turnas, a Whole Foods executive who has held other key leadership roles including President of the company’s North Atlantic and United Kingdom regions.

I do not believe that this new venture will be successful for Whole Foods. The company is exploring outside of their circle of competence with this initiative.

By entering into markets where cost-conscious consumers shop, they are taking away Whole Foods’ main differentiator.

By attempting to compete on cost rather than on quality, Whole Foods is going against their original business model. They are entering the ruthlessly competitive retail grocery store market.

I do not expect that the 365 brand will be a significant driver of business growth for Whole Foods moving forward.

Competitive Advantage & Recession Performance

From the standpoint of competitive advantages, Whole Foods benefits from being the first major player in the health food industry. For many, they are the first supermarket that comes to mind when thinking of healthy foods.

That being said, Whole Foods sells premium products. Consumers are likely to switch from Whole Foods to a cheaper alternative during periods of economic downturn.

For this reason, I would not expect Whole Foods to be a strong performer during recessions. The data backs this up.

Whole Foods completely eliminated their dividend for two years during the global financial crisis.

Their earnings per share also suffered dramatically.

Whole Foods Recession Performance

Source: Value Line

As you can see, Whole Foods earnings per share took a 37% haircut in 2008.

Based on their business model and past recession performance, Whole Foods is not expected to be a strong performer during periods of economic downturn.

Valuation & Expected Returns

Because of concerns related to Whole Foods’ growth, the company’s stock has underperformed its’ peer groups over the past few years.

Whole Foods Underperformance Relative To Peers

Source: Whole Foods 2016 10-K

While some might argue that this presents a buying opportunity, the company is not attractively valued based on earnings when you consider their growth prospects.

Based on today’s stock price of ~$32.50 and fiscal 2016’s diluted EPS of $1.55, Whole Foods trades at 21.0 times last year’s earnings.

Based on management’s guidance of $1.42 (or greater) expectations for fiscal 2017’s diluted EPS, Whole Foods trades at 22.9 times next year’s earnings.

Whole Foods PE Ratio

Source: Value Line

In either case, the company trades below both its historical average and the S&P 500’s PE ratio of 26.

However, this slightly lower valuation multiple does not scream “value,” and is simply a result of the company’s lackluster future growth prospects.

Drivers of business growth for this company will be based on the following, with the sales growth and comps guided by management and the dividend yield calculated manually.

It is consensus that Whole Foods will have flat EPS numbers over the next two years. This means that investors can expect all returns to come from dividend yield and expansion of valuation multiples, as well as share buybacks (Whole Foods repurchased $944 million of stock in fiscal 2016).

In other words, current investors in Whole Foods can expect total returns of 1.7% +/- multiple expansion + share buybacks.

Unfortunately, based on the company’s lackluster growth prospects, I don’t’ expect multiple expansion to occur. My expectations are for Whole Foods’ under performance to continue, and for the stock to continue to lag the market in the short-to-mid term (0-3 years).

Final Thoughts

Whole Foods was billed as a growth stock for year.  Earnings-per-share more than tripled from 2000 through 2008.  But the company’s rapid growth phase appears to be behind it.

Given the company’s unimpressive growth prospects and their troubling growth (or lack thereof) in same store sales, Whole Foods does not present an attractive buying opportunity at today’s levels.


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