Whole Foods stock is rotting away

Whole Foods is the worst performer in the S&P 500 this year. Shares are down nearly 35%.

Why is the stock doing so poorly? Competition from larger retailers is eating into Whole Foods’ earnings.

The organic market chain’s recent troubles began back in November. That’s when the company lowered its sales and profit outlook for fiscal 2014.

Shares of Whole Foods are, like the organic products it sells, pretty expensive. Before the earnings warning, shares were trading at about 37 times 2014 profit forecasts. When a stock is that richly valued, investors expect nothing less than perfection.

But Whole Foods has continued to be the Wall Street equivalent of a rotting pile of produce.

Whole Foods cut its targets again in February … and once more earlier this month. In November, it said annual profits could be as high as $1.72 a share. It now thinks that earnings could be as low as $1.52 a share.

Interestingly, Whole Foods seems to be a victim of its own success.

It’s not as if customers have abandoned healthy eating. Quinoa, kale and tofu are still hot. It’s just that consumers can get their organic fix … often for much lower prices … at places like Wal-Mart, Kroger, Costco and privately held Trader Joe’s.

Ironically, Wal-Mart unveiled a new partnership with organic food company Wild Oats last month. Whole Foods purchased Wild Oats in 2007 but was forced to sell the chain and the brand name in 2009 after the Federal Trade Commission ruled that the deal was violating antitrust laws.

In a not-so-subtle jab at Whole Foods, Wal-Mart noted in the headline of its press release that it would offer Wild Oats products in order to “drive down organic food prices.”

In addition to facing more challenges from much bigger retailers, Whole Foods is also having to fend off scrappy upstarts … and they all seem to be losing in the process.

Shares of other pure play organic food retailers have also been hit hard this year. The Fresh Market and Sprouts Farmer Market are both down nearly 30%.

And my beloved Fairway is down nearly 66% in 2014. (Excuse me for going all hyperlocal on you. But it appears that a new-ish Whole Foods in the Gowanus section of Brooklyn is stealing some thunder from the big Fairway in Red Hook.)

But back to Whole Foods. Has the stock finally bottomed? You could argue that the big sell-off is overdone. After all, the low end of the company’s new earnings target of $1.52 a share is just 12% below the $1.72 a share it was predicting back in November.

Should a stock really fall more than 40% in six months and a 12% reduction in its earnings outlook?

It might be a bit much. But bear in mind that Whole Foods has made it a nasty habit to keep cutting its targets. What’s to say that Whole Foods doesn’t lower its outlook again when it reports its third quarter results in late July or early August?

The biggest problem facing the company right now is … to quote Billy Joel … a matter of trust. (One. Two. Ah one, two, three, four! I’m from Long Island. Sorry.)

During the company’s conference call with analysts after announcing earnings a few weeks ago, J.P. Morgan analyst Kenneth Goldman had a very pointed question/comment.

“One of the questions I’ve been getting lately is, ‘Does Whole Foods management appreciate that the world has changed and there’s a lot more competition out there?’ I’ve got to be honest. I’m not really hearing anything that’s suggesting management is taking this situation as seriously as some investors want you to,” he said.

Whole Foods co-CEO John Mackey noted that Whole Foods has been lowering prices, but Goldman interrupted to point out that the company had been doing that for years. Mackey countered by saying that the company would be even more aggressive.

In response to another question about competition, Mackey mentioned Kroger, Trader Joe’s, Sprouts and The Fresh Market by name.

He said Whole Foods is still the market share leader in organic foods and added that he thinks the growth potential in the business is the reason why “all these guys are jumping into it.”

But Whole Foods can’t just rest on its laurels. Mackey acknowledged that.

“I think for a long time Whole Foods had the field to ourselves, pretty much. That was nice,” he said. “But we don’t any longer.”

Wall Street has figured that out already. That’s why the stock is down. And what we might be seeing now is a realization that Whole Foods’ best days are behind it.

The stock is not as frothy as it was back in November. But it still trades at 25 times fiscal 2014 earnings estimates. That may be too expensive for a company whose profits are expected to grow about 13% a year, on average for the next few years.

Just look at Kroger. Analysts are forecasting annual earnings growth of 11%, on average, for the next few years. But its stock trades at just 15 times 2014 earnings estimates.

It’s no wonder then that Kroger (which also owns SoCal staple Ralphs, aka The Dude from The Big Lebowski’s favorite supermarket) has been a hit at Wall Street’s checkout line this year. (Is there a Ralphs around here?)

Consumers (and investors) may be willing to pay more for quality. But if you can buy a wheat berry salad at Kroger for a much cheaper price than at Whole Foods, then you probably will. Same goes for the stocks. Whole Foods is no longer worth the premium it once commanded.