Whole Foods Under Pressure; Is It Still a Good Buy?

Whole Foods Under Pressure; Is It Still a Good Buy?

Competition is heating up in the organic food and natural products market. Existing players are joining the bandwagon by dedicating separate sections in their stores to organic food and supplies in an attempt to drive sales, creating pressure on pure-play organic food players that are taking a hit to their margins.

As a result, Whole Foods Market , which is a specialty grocery retailer in the organic and natural food products market, is facing competition from the likes of Safeway and Kroger . Both Safeway and Kroger have also started offering organic food products to cash in on the organic food wave.

The opportunity
As consumers are becoming more aware about the effects of genetically modified, or GMO, food and repercussions of the industrial fertilizers and pesticides used in farming, they are looking for more transparency in the food they eat. As a result of this, it is expected that the market for organic food in the U.S. will exceed $80 billion by 2015. The organic and natural food market still has large potential for further growth. In 2012, this market was just 3.5% of total food sales in the U.S.

Whole Foods under pressure
Whole Foods Market has been at the forefront of the organic food revolution, but it is now witnessing certain challenges. In the fourth quarter, it posted a 2% increase in revenue to $2.98 billion . However, pricing pressures as a result of heated competition weighed on the top line. The company reported earnings of $0.32 per share, 7% more than the same quarter in the previous year.

Going forward, Whole Foods expects revenue to increase by 11% to 13% in 2014, along with a 5.5% to 7% rise in comparable-store sales. Earlier, Whole Foods had forecast 12%-14% growth in revenue as a result of 6.5% to 8% rise in comparable-store sales. Earnings are projected to be between $1.65 and $1.69 per share, accounting for a year-over-year jump of 12% to 15%, down from a range of $1.69 to $1.72 forecast earlier.

These downward revisions in guidance didn't go down well with investors and the stock tanked by 9.2% after the results.

Whole Foods opened 12 new stores during the fourth quarter, taking the total store count to 367. During the first quarter of 2014, it has already opened five stores and plans to open five more. Going forward, the company plans to open 33 to 38 stores in fiscal 2014 and 35 to 40 stores in fiscal 2015. Also, the company believes that there is room for 1,000 stores in the long run, and it is also contemplating expanding in Canada and the United Kingdom.

Kroger and Safeway turning on the heat
Whole Foods will have to put up with competition from the other grocers such as Kroger. Kroger is also offering organic and natural food products in its stores. It posted solid results recently and has been braving competition by slashing prices. Despite stiff competition, Kroger has increased its market share in nine out of 17 markets as compared to Wal-Mart. Earnings increased 17.6% from the same quarter a year ago to $0.60 per share. Revenue increased 4.6% to $22.7 billion .

Kroger has also been expanding by way of acquisitions. In July this year, Kroger announced the acquisition of Harris Teeter Supermarkets in a deal worth $2.44 billion . Once the deal is formally through, Kroger will be able to expand its reach in the Southeast and Mid-Atlantic U.S. markets.

Safeway is the second-largest supermarket operator in the U.S. after Kroger, primarily operating as a food and drug retailer. Just like Kroger, Safeway also offers organic products through its O Organics brand, which includes more than 300 items including vegetables .

Safeway has been going through strategic changes like selling its assets in Canada and preparing to exit the Chicago market in 2014, where it operates 72 Dominick's stores. It is also experimenting with the idea of apartments over Safeway stores . So far, its plans have worked out fine as it reported third-quarter revenue growth of 1.1% and beat Street estimates.

Safeway is also promoting private-label brands in an attempt to increase profitability. Private-label sales were up by 34 basis points to 27.8% in dollar terms in the third quarter. Also, the "Just for you" loyalty program is on track to bring in over six million members by the end of this year.

Whole Foods is facing strong competition from the product offerings of its peers. Even though its expansion strategy and store potential look promising, a steep valuation could put investors off. With a P/E ratio of close to 40, Whole Foods is quite expensive, especially comparing it to the industry average P/E ratio of 23.87. It has also reduced its growth forecasts, which is another reason why I do not expect any upside from Whole Foods going forward. Hence, Whole Foods looks like a stock to stay away from.

The article Whole Foods Under Pressure; Is It Still a Good Buy? originally appeared on Fool.com.

Fool contributor Sharda Sharma has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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