We reiterate our Sell rating on Whole Foods (WFMI), as we think there is further downside ahead for the stock. In our view, the company is transitioning from being an exceptional growth story to being just an above-average growth story. The difference is the premium investors are willing to pay for higher growth stocks. At over 27 times our fiscal 2007 EPS [earnings per share] estimate, WFMI shares are still valued like a higher growth stock. When the company reports slower growth in the quarters ahead, as it announced it would in its fourth quarter report, investors will most likely be disappointed. As a result, we believe the stock will slide down to $30, or about 20 times our fiscal year 2007 EPS estimate.
In its fourth quarter report, Whole Foods cautioned investors that fiscal year 2007 was going to be transitional for the company, and its growth rate was going to revert back to its historical range. This was clearly not good news for a growth-story stock like Whole Foods, which has traded at a premium price-to-earnings multiple for some time. In the wake of Whole Foods' fourth quarter report, growth investors who bid up WFMI shares to its high-flyer multiple were selling out of their positions because they realize the days of superior growth are over for Whole Foods.
So how did Whole Foods get to this point of transition? Simply put, the company is a victim of its success. WFMI’s impressive growth over the last several years demonstrated that the company was taking full advantage of the growing demand for organic foods. However, its competitors also recognized this demand and began to sell more organic foods in their stores. This set the stage for a more difficult sales growth and profit margin expansion.