Why Whole Foods Could Finally Be a Buy for Some Investors

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Whole Foods Market Inc. (NYSE: WFM) is so ugly in its post-earnings reaction that investors, new and old alike, will have to admit that the future is suddenly very different from the past. This organic and natural foods retail giant has grown and grown, and it seems safe to assume that the easy money has now been made by investors. Still, this drop is so large and so nasty that some long-term investors may finally decide in the days and weeks ahead that the baby has been tossed out with the bath water.

The big question is whether Wall Street is being too harsh and backward looking here. Analysts and strategists are known for getting it wrong over and over, and the number of downgrades would only not be alarming to the most extreme market contrarian investors.

Make no mistake in understanding one thing: Whole Foods just took a serious damage to its investor credibility quotient. Whole Foods keeps adding stores and still has many growth opportunities ahead of it. It is also easy to see that it will now have to fight for new growth, and in a world where price matters it will have to fight to hang on to its grasp of existing markets and existing customers as well.

Do investors have to worry that the new Whole Foods is simply the same as investing in Kroger Co. (NYSE: KR)? Or what about The Fresh Market Inc. (NASDAQ: TFM)?

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Admittedly, past investors wanted high growth here. Yet net income of $142 million, or $0.38 per share, for the second quarter was effectively flat against the same quarter a year ago. Total sales rose 10% to a record $3.32 billion, while the more important same-store sales rose by 4.5%. Where things go awry was that the Thomson Reuters consensus was $0.41 in earnings per share on revenue of $3.34 billion.

Again, it sounds sketchy to existing Whole Foods shareholders who have grown to expect more out of the company. And guidance will leave more questions for those same long-term investors who expected more. Guidance for 2014 is for earnings of $1.52 to $1.56 per share, with sales growth of 10.5% to 11%. The company’s prior guidance was for earnings per share of $1.58 to $1.65, and for sales growth of 11% to 12%. Prior to the guidance, Thomson Reuters was calling for $1.61 per share and closer to 11% revenue growth.

Our own take through time has been that its stock has been overvalued to those who used traditional metrics, and that it was to be evaluated as a luxury retail growth story rather than a low margin grocer. Just keep in mind that Whole Foods is likely to see ever lower margins ahead.

So, how is Wall Street’s reaction now, besides just being flooded with analyst downgrades?

Credit Suisse pointed out in its earnings preview at the end of April, when it still had a Neutral rating, that things were bad. Its team opined that emerging headwinds suggested that the share pullback may in fact not be a buying opportunity. Now Credit Suisse maintains that the days of easy growth is over and the company will have to shift its strategy to address intensifying competition.

The downgrades are coming on strong elsewhere. The following downgrades were seen on Wednesday morning: to Market Perform from Outperform at BMO Capital Markets, to Sell from Hold by Cantor Fitzgerald, to Hold from Buy at Deutsche Bank, to Neutral from Overweight by Piper Jaffray and to Neutral from Buy at Sterne Agee. Again, there is no way that any investor will think that this many downgrades is good news. Only extreme contrarians would like the news, and even then they may say to be patient.

Other analysts have remained positive in their ratings, with very tempered expectations. Canaccord Genuity said that the bloom has fallen off the organic rose. Still it maintained its formal Buy rating while slashing its analyst price target to $49 from $63. The independent research firm of Argus actually came out and raised its official Whole Foods rating to Buy from Hold, with a $48 price target, as it has said that investors can finally buy this stock at the price it wanted.

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Whole Foods shares were down a whopping 19.5% at $38.58 in early afternoon trading on Wednesday. The trading volume was also more than 32 million shares, with much time left in the day, more than six times a full day’s average volume. Put simply, this is a game changing day for Whole Foods.