Why I Love Whole Foods but Can’t Buy the Stock

I want to start by saying that I love shopping at Whole Foods. The retailer offers a superior customer experience and provides an extensive range of natural produce. However, despite the company being well positioned to benefit from the long term structural growth trend in organic food consumption, I just can’t bring myself to purchase the stock.

Last week, the company announced that same-store sales had turned negative, down 0.2% for the quarter. While total sales increased 6%, this is still the weakest results since 2010. In addition, the company indicated that comps will probably stay flat next year. Margins also remained under pressure – gross margins declined 96bps due to an increase in cost of goods sold.

These disappointing numbers are not overly surprising. Whole Foods operates in an intensely competitive industry – one where switching costs are virtually non-existent. Their success over the last few years was bound to attract new entrants. This has certainly been the case as competition has intensified from firms like Trader Joe’s, Kroger, Wal-Mart, and Costco. In light of this, it seems logical that Whole Foods would be eager to reinvest heavily in the business. The company has flagged it plans to increase spending in numerous areas, including its online presence, the cloud, point of sale systems, customer loyalty programs and 365 by Whole Foods. This reinvestment will prove vital as it will be the key to ensuring Whole Foods can maintain their price premium and sustain traffic in the future.

However, the one thing I can’t understand is why the company is using its current free cash flow (and borrowing an additional $1bn!) to buy back stock… Its hard to believe that buying back a substantial amount of stock is really the best use of capital for a company that has under invested and needs to “get back to basics” (as Co-CEO John Mackey put it). To me, leveraging the balance sheet to boost EPS is a short term play – and one that is hard to justify when the stock is trading at 19x.

In any event, the question becomes can Whole Foods return to being the phenomenal growth company it once was?

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