Why Whole Foods Shares Need to Be Avoided

Source: Thinkstock

Source: Thinkstock

When I last wrote about Whole Foods (NASDAQ:WFM) a month ago, the stock had been relatively weak compared with the rest of the market. I suggested that investors should consider to stay away given that growth stocks were showing signs of weakness and Whole Foods operates in a pretty competitive environment.

Since then, the stock has plummeted. When the company reported its first-quarter earnings, we learned that the company’s revenue growth is shrinking, its margins are compressing, and going forward the company will face competitive pressure that will force it to lower its prices. Let’s look at the specifics.

Whole Foods reported sales of $3.3 billion in the first-quarter versus $3 billion a year earlier, which is a 10 percent increase. Considering how weak the overall market is, especially in the retail space, this seems great. Unfortunately, if we look at the company’s profits we find that margins are compressing. The company’s operating income rose just 1 percent from $228 million to $231 million, and its net income was flat at $142 million.

This margin compression is the real issue, and it is the reason that the stock is down so much and why it has continued to be weak. It is also the reason why I think the stock remains expensive at 25 times trailing earnings and at 25 times 2014 earnings expectations. It is very difficult to get behind the stock of a company that will not be growing its profits if it trades at 25 times earnings.