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Whole Foods and the Mysteries of Sell-Side Research

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Whole Foods is just another grocery store with some expensive icing on its cakes.

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Of all the sell-side research I follow, the model-laden reports by Morgan Stanley (MS) are by far the most useful because they let me focus on the numbers I find most relevant to a specific company, and from which I can then draw my own conclusions. I rarely pay much if any attention to the commentary or opinions, except as a tool to challenge my thinking.

Occasionally however, there is that unique report that, in an effort to lay out a positive or negative story on a name, creates the perfect backdrop to reach precisely the opposite conclusion. The last such gem dates back to almost exactly a year ago and pertained to Cendant (CD). The anniversary edition comes courtesy of Whole Foods (WFMI). Here are Morgan's conclusions after WFMI's bomb and Friday's 25% haircut:

  • WFMI's long term growth rate is pegged at 18-20%, therefore the stock should bottom out at 27-30x 2007 EPS estimate of 1.50.

  • WFMI should bottom out at 27-30x estimates because that's where it bottomed out after the 3Q report.

  • WFMI should ultimately trade at a 40 multiple because Starbucks (SBUX) is a similar company and trades at a 40 multiple.


I kid you not Minyans, that is the entire analysis to justify a $63 price target. To go along with that program one simply has to:

  • Ignore that for the next 3 years WFMI's growth rate – if all goes well – will average 14%, and that even if WFMI were to grow for 20% per year for year 4, 5 and 6, its growth rate will still only average out to 17% for a six year period.

  • Ignore that suggesting a 27-30 multiple for any stock – let alone one growing 14% for the next three years – without some other specific reason or catalyst is at a minimum a "non-sequitur," and more likely a mysterious leap of faith.

  • Ignore that after 3Q WFMI bottomed out at a 27-30 multiple on estimates that were $0.15-0.20 higher than they are now, and on sale comps guidance 20%-30% higher than what the company issued Thursday.

  • Ignore that the similarities between SBUX and WFMI end at the fact that they both sell edibles. Just for starters, the average ticket size at WFMI is $32 vs. – and I'm guessing – south of $6 for SBUX. Which do you think a consumer will be more conscious of?

  • Ignore that the market is willing to pay low to mid teen multiples for Safeway's (SWY) 12% estimated long term growth rate, despite the fact that SWY is comfortably free cash flow positive, while WFMI FCF trend is heading toward the negative.

  • Ignore that any grocery store chain that wishes to have anything resembling a future will only intensify penetration in the organic food business, and perhaps even gun directly for WFMI while the company is facing troubles.

  • And lastly – and because I suspect you know where I am going with this – one would have to ignore that WFMI has now joined the ranks of broken growth / cult / momentum stories, and will likely need to undergo a rather complete change in investor base, from growth investors to GARP / value investors, which suggests that the stock will not likely find a bottom until the valuations suit the latter groups.


IMHO, Friday's 25% showed that the there was a deep disconnect between what investors / traders thought they owned and what they actually did own. The plunge did not reconcile the disconnect, it merely brought it to the market's attention. Unless one believes in Morgan's "imaginarium" trip, the reconciliation process between WFMI and the buyers will likely be a long price-searching process that won't end until the two sides can agree that WFMI is just another grocery store with some expensive icing on its cakes.

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Position in WFMI
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