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This year has not been kind to Whole Foods Market (NASDAQ: WFM). The organic and specialty foods retailer has battled against intensifying competition in the United States. This has weighed down its revenue and earnings growth, even though the boom in demand for organics continues to strengthen.
Shares of Whole Foods have declined by 40% year-to-date, while the S&P 500 is flat for the year. Whole Foods was once a premier growth stock, but as its growth has slowed down, investors are fleeing. The good news is that Whole Foods stock may finally be a good buying opportunity, as it is cheaper than it has been in years.
If Whole Foods can execute on its plan to restore growth, the stock may be an attractive investment.
Slowing Growth, Shareholder Exodus
Investors have rushed for the exits this year, primarily because Whole Foods’ underlying growth is slowing down. Comparable sales, which measures sales at stores open at least one year, fell 0.2% last quarter. This was a shock, because Whole Foods investors were accustomed to high single-digit comparable sales growth for many years. Meanwhile, earnings per share fell 5% for the full year.
In response, Whole Foods is embarking on significant cost-cutting to restore profit growth. The company has announced a series of cost-cutting initiatives, including layoffs, that will save $300 million per year by the end of fiscal 2017. And, the company has a plan to fight back against the competition.
Competition is really heating up in the United States, as smaller players like The Fresh Market (NASDAQ: TFM) and Sprouts Farmers Market (NASDAQ: SFM) carve out their own niches. Making matters worse for Whole Foods is that bigger grocers like Kroger Co. (NYSE: KR) are building out their own organics offerings, at discounted prices.
As a result, Whole Foods has a plan to compete. It is unveiling its own discounted brand, 365, through new, smaller outlets. Whole Foods plans to open three of its 365 stores this year, and up to 10 in fiscal 2017. This will allow the company to take back share and compete in the lower tier. These stores will allow Whole Foods to service a whole new customer demographic that it could not serve with its larger Whole Foods Market stores.
Even though growth is slowing down, Whole Foods continues to generate industry-leading margins. It produced a 15% return on invested capital last quarter. Moreover, Whole Foods continues to generate a lot of cash, which the company is aggressively returning to shareholders.
Huge Cash Returns to Keep Investors Happy
In an attempt to soothe investors’ fears, Whole Foods recently announced a major increase to its capital return program. Going forward, the company will buy back $1 billion of its own stock. Whole Foods expects to implement the buyback in the first half of 2016.
This is a good idea, since Whole Foods generates a lot of cash flow and carries a strong balance sheet. The company raked in $1.1 billion of operating cash flow last year, which set a record. Whole Foods has $455 million in cash and marketable investments. Its long-term debt to equity ratio is a modest 19%. Whole Foods expects its huge buybacks to be accretive to earnings per share this year.
In addition, Whole Foods recently increased its dividend by 4%. Whole Foods has raised its dividend five years in a row, since reinstating its payout in 2011. At its recent closing price, the stock yields 1.8%.
The Good News: Stock Is Cheap
The good news is that as shareholders keep pushing the stock lower, shares become cheaper on almost a daily basis. The end result is that on a valuation basis, Whole Foods has not been this cheap in years. The stock trades for 18 times earnings, which is actually below the broader market valuation. The S&P 500 index trades for 19 times earnings.
This is an anomaly, because Whole Foods stock has typically enjoyed a robust valuation multiple. The stock traded for more than 40 times earnings as recently as last year. Investors are not willing to pay a high multiple while comparable sales are declining, but if Whole Foods’ turnaround plan materializes, the stock could handsomely reward shareholders next year.
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