Tuesday, November 11, 2008

A View of Whole Foods in August 2008

In August 2008 Sham Gad thought very highly of Whole Foods stock. Now that Whole Foods (WFMI) stock has reached a share price that is almost a 10 year low I am curious what Mr. Sham Gad thinks of the stock.
This is Mr. Sham's article:

Whole Foods Is Worth a Whole Lot More
By Sham Gad
RealMoney.com Contributor
8/20/2008 12:59 PM EDT
URL: http://www.thestreet.com/p/rmoney/investing/10434043.html

One of my favorite investors once remarked, "You pay an expensive price for a cheery consensus." Indeed. When is the last time you found bargain investments among today's popular investment groups? It rarely ever happens. The commodities sector is case in point. While I believe the long-term outlook for commodities is strong, that doesn't mean I would go out and quickly invest in the industry. Anyone with a pulse knows that oil prices have soared and pushed up the prices of gasoline, diesel fuel and heating oil. Largely hidden from view, however, have been steep and continuing price increases across a basket of commodities. Coal sold for about $30 a ton during 2003, and hit $139 in 2008 before slipping back a bit, tripling in 12 months. Copper went from 82 cents a pound in July 2003 to $3.72 by the end of last month, an increase of 350% over five years. The price of steel has climbed from under $240 a ton for hot-rolled steel in 2003 to $1,125 a ton last month, a fourfold rise in five years. Grain prices are no exception. U.S. corn prices jumped from $3.01 a bushel in July 2007 to $5.37 one year later. Wheat doubled from $3.05 a bushel to $6.02 over the past two years. The old adage, "what has risen shall fall and what has fallen shall again rise" rings very true in investing. Blindly investing in commodities today can lead to some very quick and painful results. Just look at a few oil companies' equity prices over the past few weeks as oil has fallen from $147 to $113 a barrel. They have fallen just as quickly. Believe it or not, some of the best opportunities today lie outside the commodities and in areas where many investors frown upon.
The Economic Case
When demand is high, prices rise; conversely when demand softens, prices fall. This principle also applies to stock prices. Right now, energy and commodity businesses are the hot topics. Unfortunately, the real money was made a few years ago when corn, wheat and coal were considered boring topics, and patient investors were picking up businesses on the cheap. Enterprising investors would be well served to look in today's orphaned sectors. Hundreds of businesses have lost 50% or more of their market valuations over the past year or two. Understand, however, that a cheap stock does not equate to an undervalued investment opportunity, and an undervalued business is not necessarily characterized by a cheap stock price. A wonderful example is Whole Foods (WFMI) .
Pricey Food, Affordable Stock
For years, I have been a big admirer of Whole Foods. The quality of the business of is evident the minute you step inside one of its stores. For years, Whole Foods was the darling of Wall Street. Between 2002 and 2006, shares leapt from $18 to nearly $80 a share, and the average annual P/E ratio was over 35. During this time, the company traded for as high as seven times book. Now, with consumers cutting back, the grocer has felt the pain. The most recent quarter's results indicate choppy waters ahead. The company lost nearly 18% of its value in a single day. Make no mistake, Whole Foods is experiencing a very tough operating environment. Management indicated as much when they announced that they would be reducing expansion plans for the rest of the year. But now, with the stock at $18, the P/E is 18, and the company sells for less than two times book value, investors are avoiding it. Yet Whole Foods is a business with a wonderful economic moat. With the sticky acquisition of Wild Oats behind it, Whole Foods has eliminated its biggest competitor. Even Wal-Mart (WMT) , with its might, has yet to do anything to damage the Whole Foods brand. As a value investor, what has me so excited about Whole Foods at the current prices is simply this: to any potential buyer, Whole Foods is worth a whole lot more than its current market value of $2.65 billion. The exact figure, no one knows; but the company's assets, brand recognition, market dominance and growth prospects all add up to something more than $3 billion. Just think of how long and expensive it would be for Wal-Mart or Kroger (KR) to build a 270-store organic food chain in some of the country's top real estate locations -- and then spending the marketing dollars to achieve the image and recognition that Whole Foods has. It won't happen for $2.65 billion. In the organic and natural foods industry, Whole Foods is the Coca-Cola (KO) : it owns the market. Markets environments like today reward the investor who can anticipate what is to come. Under a tough consumer environment, Whole Food's pricier fare looks like a suckers bet. Yet, many of its customers view their food habits as a lifestyle necessity, and are more tolerant of price changes. Besides, if conventional food prices continue to rise, the value of natural foods may look better. If you are expecting results next month or next quarter, you might not like the ones you get. But if you can analyze a business through the looking glass of a multi-year period, now is a good time to look at some quality unpopular businesses. As famed investor Shelby Davis aptly remarked, "You make your best money in bear markets, you just don't know it at the time."

At the time of publication, Gad had no positions in the stocks mentioned, although positions may change at any time. Sham Gad is the managing partner of the Gad Partners Fund, a value-centric investment partnership modeled after the original 1950s' Buffett Partnerships. Previously, Gad was a writer for The Motley Fool and a securities analyst for UAS Asset Management, a small, value-focused fund in New York City. Gad also runs a value investing blog inspired by the teachings of Benjamin Graham and Warren Buffett. Gad is working on a value investing book (title forthcoming) to be published by John Wiley and Sons in the summer of 2009. Reach Gad at sham@gadcapital.com.