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Lowering Our Outlook for Whole Foods

We are decreasing our fair value estimate for Whole Foods as we now expect the grocery-store chain will no longer be able to expand its profit margin over time, writes Morningstar’s Ken Perkins.


We are placing our $40 fair value estimate for narrow-moat  Whole Foods (WFM) under review and will probably lower it to around $30, as we are decreasing our long-term store growth, same-store sales (to 3% from 4%), and margin assumptions (to 5.5% operating margin from 6.5%). Our previous view was that Whole Foods could expand margins so long as it continued taking its fair share of industry growth (mid to high single digits). The firm's traffic has been increasing 2%-3% for some time despite increasing competition, supporting our view; an assumption of 2% traffic growth along with modestly larger baskets would have put Whole Foods' comparable-store sales comfortably in the mid-single-digit range, a sufficient level to generate leverage and expand operating margins.

However, management now expects sales to increase only 3%-5% next year, with flat comps. We do believe the grocery market will reach a new equilibrium, and we foresee Whole Foods increasing same-store sales around 3% annually over the long term once its share losses moderate; however, 3% comp growth isn't enough to drive much margin expansion, and we are less convinced that Whole Foods can drive a reacceleration in same-store sales growth.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.