What You Will Learn
- Whether it’s time to sell Whole Foods
- The potential of the organic food industry
- What Whole Foods is worth today
- A PDF report is available to download at the end
6 months ago, two valuation articles on Whole Foods Market (WFM) were published here.
- Whole Foods Market is a BMW. Stop Comparing it to a Kia.
- Why Whole Foods is Cheap. Take Advantage of Mr Market’s Panic.
In the first article I valued Whole Foods between $38 to $48.
My method is to stick to a valuation range when calculating intrinsic value, but it doesn’t mean you have to.
The second article was written by Old School Value member Dan where he valued Whole Foods at $54.90.
Here’s Dan’s valuation from 6 months ago and the stock price after the 2015 Q1 earnings report.
The stock is trading higher compared to the after hours trading price of $54.90, but to have the stock close at the exact same valuation is still a rare feat.
So What Happened to Whole Foods?
With large caps, there is a lot of noise.
The stock market is efficient to some degree, but when there is a hint of uncertainty, all that efficiency flies out the window.
The fear was that Wal-Mart, smaller competitors like The Fresh Market (TFM), Sprouts Farmers Market (SFM) and grocery chains like Kroger (KR) and Safeway (SWY) would eat away all of Whole Foods margins and customers.
So far that hasn’t happened.
Comparable store sales increased 4.5% in the quarter, number of transactions was up, and margins have not taken a dive as feared.
The improvements look to continue into Q2 based on the very short Feb data that was released in the 8K.
Time to Sell Whole Foods?
With the stock up about 50% since I last wrote about it, is it time to sell?
If this was a mediocre business or something I picked up to flip, then it’s definitely a sell once it hits intrinsic value.
But for a company like Whole Foods, it’s better to reassess where the company stands and where the industry is going.
The organic food industry is expected to grow 14% from 2013 to 2018 according to the United States Organic Food Market Forecast and Opportunities.
Based on the report, a group of consumers labeled the “true believers” account for 46% of all organic/natural product sales. So that means that there is a still a huge population that do not shop organic or natural products.
And this is a huge driver because consider the following simple ideas:
- the organic market is definitely going to get larger
- healthy eating and anti-GMO is here to stay
- generation Y’ers (born in 1980’s and 90’s) will drive the growth as they make up a huge portion of the population (25% back in 2009 and 22% expected in 2030)
So there is still a massive opportunity for Whole Foods to reach a bigger audience. Competitors will also benefit with this growth, but that just means the industry is healthy.
The opportunity is big enough for Whole Foods to target 1200 large format stores.
With strong tailwinds, it’s going to be tough for me to sell out my position entirely.
So let’s move onto to see what it’s worth today and whether it makes sense to hold or sell.
Updated DCF Valuation
Since we are only one quarter into the fiscal year, I’ll use last years numbers to gauge FCF and maintenance capex.
What I like about Whole Foods is their accounting and reporting is very transparent and value focused.
Their core key performance indicators include FCF and ROIC which is a value investors dream.
It makes it so much easier to run a DCF when management practically breaks down the numbers for you.
Based on the 2014 filing and the numbers for capex, here’s a breakdown of the calculation.
- 38 new stores were opened in 2014
- Total capex for 2014 was $710m
- Growth capex for new stores was $447m
- Therefore, maintenance capex = $710m-$447m = $263m which is 26% of cash from operations
- Divide $447m by 38 to get the average cost to open a new store = $11.7m
- Multiply $11.7m by the 2015 forecasted new stores of 40 = $470m for 2015 growth capex
- Going back through historical numbers, the last 4 years average maintenance capex was about 20% of cash from operations but 2014 was 26%. I’ll use the higher percentage to keep it conservative when calculating the 2015 numbers.
- Because WFM is targeting sales growth over 9%, a 9% increase of 2014 cash from operations is $1190m
- Now take 26% of $1186m to get maintenance capex of approx $310m
Now for the DCF:
- 9% discount rate
- using a growth range from 12% to 14% including a decay rate
- 2015 owner earnings of $880m ($1190m – $310m)
With a 12% growth rate, the fair value comes out to $46.28.
With a 14% growth rate, the fair value comes out to $51.49.
I’ve added a sensitivity matrix to show how the values can vary based on the growth and discount rates.
With a discount rate of 7% and 14% growth rate, the fair value goes from $51.50 to $61.82.
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Updated EBIT Multiple Valuation
Time to look at it from another angle instead of getting locked in to one method.
Using two different revenue estimates, here are the fair value estimates using the EBIT multiple method.
The first screenshot you see below is based on 2015 revenue estimates of $15.75 billion which gives a value close to the current stock price.
But what if Whole Foods continues to improve and compound?
You know, Buffett style.
Here I’m using the 2016 estimate revenue of $18 billion which gives a fair value of $60.
If Whole Foods is one of those companies that has Buffett and Munger investment characteristics, it’s a fairly valued company with big compounding and wealth generating abilities.
It’s difficult to look too far out into the future and at the moment, Whole Foods is in fairly valued territory. The different valuation methods and viewpoints confirm this.
Although I see Whole Foods belonging to the $50-$60 fair value range at the moment, I won’t be selling out of my position completely.
The company is run by great managers, operates an ethical business supported by communities. Management clearly has the capability to compound and further enhance intrinsic value.
Here’s a better explanation by Francis Chou.
I have bought companies that were anything from financially and operationally distressed companies to wonderful, financially sound companies, and in my experience there is an immense benefit in buying outstanding companies that does not show up in numbers. There are numerous hidden margins of safety in 1) wonderful economics of the business, 2) great management who know how to allocate capital, 3) growing and sustainable free cash flow that are being deployed wisely, 4) you can make a mistake of paying up and still it may not matter that much because the intrinsic value is growing at a reasonable clip, and so on. The difficulty is in identifying them.
I see this as a Buffettesque company that I’ll be happy owning for many years to come.
Lastly, here’s a graphic of how I see the company today.
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