Tuesday, September 21, 2010

Whole Foods Market (NASDAQ:WFMI): Weakening Sales and Nosebleed Valuation a Bad Combo; Downgrading to Underperform - CSFB

Credit Suisse is making a big call on Whole Foods Market (NASDAQ:WFMI) downgrading the high end retailer to Underperform from Neutral with a $30 price target (prev. $40).

The downgrades comes as the stock’s risk/reward appears to be heavily skewed to the downside. Whole Foods stock is up 366% from its November 2008 low versus a 43% gain for the S&P 500 over this time period. CSFB attributes much of the stock’s relative outperformance to a recovery in the high-end consumer, the company’s acceptance of its structural issues, and early moves to begin correcting its problems. While management is moving in the right direction (the biggest improvement is opening smaller stores), their channel checks suggest that fundamentals are beginning to deteriorate at this high priced momentum story. Firm now sees risk to the company’s fourth quarter fiscal 2010 and full year fiscal 2011 sales and earnings guidance, and believe the stock will grind lower as investors fully digest this issue.

CSFB believes Whole Food’s comp guidance for Q4’10 (+6.5-7.5%) and fiscal 2011 (+5-7%) is at risk. The company experienced a sharp sales recovery over the past year as the high end consumer recovered (their consumer started to spend again), with comps peaking last quarter at almost 9%. While this improvement is impressive, they believe a deceleration is likely as the company begins to cycle more difficult comparisons and believe the slowdown could be more dramatic than management expects. Firm believes comps are currently running in the 5-6% range and project a 3.5-4% increase in 2011. Their conclusion is based on the following:

- Channel checks suggest sales momentum continues to slow.
Whole Foods indicated on its Q3’10 earnings conference call in early August that its comp growth started to slow as its easy comparisons began to end. CSFB's discussions with numerous vendors and other natural/organic sources suggest that Whole Food’s sales momentum slowed further in August and September.

- Upper income consumer sentiment has started to deteriorate.

- Guidance assumes a ramp in underlying sales momentum.

Gross margins have peaked (and could be at risk). CSFB's channel checks suggest that WFMI’s promotional levels have increased recently (with slowing traffic), the company has not fixed its high-priced image in their view, and the key drivers of recent gains have already played out.

SG&A ramp is a concern. The sharp acceleration in expense growth at WFMI recently may be difficult to adjust if sales slow significantly.

Cutting estimates. Firm cuts their Q4’10 EPS est. to $0.26 from $0.29 (vs. consensus of $0.28) and their fiscal ‘11 est. to $1.53 from $1.60 (vs. $1.61).

Stock’s downside far outweighs the upside. WFMI’s valuation (24x fiscal ‘11 EPS) implies its sales/earnings momentum is sustainable in CSFB'sview. Firm's $30 TP assumes the stock will trade back to a more reasonable growth multiple (19x) once the market digests its weakening fundamentals

Notablecalls: The Credit Suisse's food retailing analyst Edward Kelly & his team are no geniuses - they started WFMI at Neutral in mid-2008 when the stock was trading at $30, watched it decline to $10 in 2009, then back up to $40 and are now slapping an Underperform on it. They missed the entire $10 -> $40 move. That's 400% in missed performance. During the 2+ years they have added zero value for their clients.

Today's call is CSFB's first attempt to create some added value. They did their checks & it came back bad. Comps have slowed, gross margin is down due to higher promotions and SG&A is accelerating.

When it comes to retail valuations, Whole Foods (WFMI) trades at a nosebleed level.

The downgrade will hurt WFMI today. I'm guessing to the tune of 5-7%, putting at least $36 level in play.

1 comment:

notablecalls said...

SO wrong I wanna puke!