Whole Foods Market, Inc. (WFM): Is This Stock a Buy After Earnings Miss?

Profits

Whole Foods has grown its EPS from $0.82 in fiscal 2008 to $2.52 in fiscal 2012, a 200% increase or about 32% annualized. Free cash flow per share has jumped from $-1.41 to $3.97 in that same time. This was fueled by annualized revenue growth of about 10%.

This growth was driven by both new store openings and by same-store sales growth. The company expects to open between 32 and 34 stores in fiscal 2013, which would increase its store count by almost 10%. In addition, the company has guided for same-store sales growth to be between 6.6% and 8% and EPS between $2.83 and $2.87. This would represent EPS growth of 12.3% on the low end.

After subtracting the net cash, Whole Foods trades at about 31 times 2012 earnings and about 20 times 2012 free cash flow.

The company has stated that 1,000 stores is a reasonable goal, so with only 345 stores so far the company can grow its store count by 10% annually for 11 years before reaching this goal.

Data from Morningstar

Is Whole Foods a Buy?

Even after the drop in stock price I think that Whole Foods is still too expensive — 31 times earnings is a high price to pay for 12% EPS growth going forward. For earnings to grow faster the operating margin would need to grow, not unreasonable given that its grown over the last few years.

If revenue grows by 12% per year over the next 11 years while operating margin rises from 6.4% to 8%, revenue would sit at $40.7 billion with EBIT at $3.26 billion. Assuming a 35% tax rate net income would be $2.12 billion. Since meaningful store growth would stop at this point growth would slow down considerably. A P/E ratio of 20 would value the company at $42.4 billion. This is 165% market cap growth in 11 years, or 9.3% annualized.

This is not a terrible result, but remember that I assumed that operating margins increase. Without that condition annualized market cap growth drops to 7.1%.

All this assumes that revenue consistently grows by 12% each year for more than a decade and that Whole Foods can at least maintain its margins. The supermarket industry is extremely competitive, and projecting anything that far in advance is a difficult prospect. If everything goes right for Whole Foods, its not an unreasonable buy at the current price. But there’s no margin of safety here. If growth starts to slow then the stock will plummet. In this case I think the risks outweigh the rewards.

The article Is This Stock a Buy After Earnings Miss? originally appeared on Fool.com and is written by Timothy Green.

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