Why Whole Foods' Biggest Problem Is Wall Street

Source: Whole Foods.

Since supermarket operator Whole Foods Market released its third fiscal quarter results on July 29, analysts and investors alike have been trying to diagnose what's wrong with the company. The stock fell like a stone after releasing its latest quarterly report, and looking back further, the stock has not performed well at all. Shares of Whole Foods are down 29% just since the beginning of the year.

Indeed, Whole Foods is facing some stiff pressure from intensifying competition. But Mr. Market seems to be in full-blown panic mode about the state of Whole Foods' business, which seems misguided. Whole Foods is still a highly profitable, growing business. As we shall soon see, a better culprit for the poor stock performance was unrealistic expectations heading into the quarterly earnings report.

Steady as she goesFirst, a quick recap of Whole Foods' quarterly results. Revenue increased 8% year over year, to a record $3.6 billion. Earnings per share rose 4% to $0.43 per share, due to rising sales as well as reduced shares outstanding.

The stock sold off on earnings for a couple of reasons. Earnings per share came in just shy of analyst expectations, which called for $0.44 per share. Also, analysts were quick to criticize Whole Foods' comparable-store sales, which grew 1.3% year over year. Comparable sales is a measure used to analyze sales at stores that were open at least one year. Lastly, Whole Foods' guidance was a bit light. Sales growth is expected to reach 7% for the full fiscal year, down from a previously projected 9% sales growth rate.

Whole Foods just missed analyst forecasts for the quarter, but that doesn't mean the company is deteriorating. Far from it; the company posted solid, if unspectacular, growth across its most important metrics, including revenue, comparable sales, and earnings per share.

Resetting expectationsParsing through Whole Foods' quarter, management stated that comparable sales slowed down considerably after week 11, implying the New York City weights and measures audit that received national media attention took a toll. Comparable sales growth averaged just 0.4% for the last two weeks of the quarter. However, this story will likely fade with time. Whole Foods apologized, and consumers' memories' tend to be short. The company already noted comparable sales accelerated again to 0.6% through the first three weeks of the current quarter. And, for all of its challenges last quarter, Whole Foods still generated a 15% return on invested capital, which is arguably very solid.

So, while Wall Street is busy re-calibrating their financial models, long term investors have a promising catalyst to look forward to: Whole Food's 365 initiative.

Stock drop could be a long-term opportunityThe "365" store banner will be Whole Foods' expansion of its lower-priced brands as a separate store concept. The company plans to open up to five of these stores by the second half of 2014. This is a promising catalyst that could bring Whole Foods to a new customer demographic slightly lower on the income scale.

Importantly, Whole Foods believes it can maintain similar profit margins at its 365 stores, even though price points will be lower. On the most recent conference call, management stated that it will enjoy much lower capital and labor costs, which could actually lead to higher returns on capital with the 365 format. Longer term, Whole Foods' management sees the potential for more than 1,200 total stores in the United States, as compared to just 424 traditional Whole Foods stores currently.

The bottom line is that Whole Foods' stock was priced as a growth stock heading into earnings, which was likely a mistake on the part of over-aggressive analysts - not WFM. Now, the stock is much more modestly valued at 21 times forward earnings according to S&P Capital IQ estimates. If Whole Foods can stabilize its core operations in the aftermath of the pricing scandal, the current dip in stock price could prove to be an excellent buying opportunity for long-term investors.

The article Why Whole Foods' Biggest Problem Is Wall Street originally appeared on Fool.com.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.