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Whole Foods has only itself to 'blame'

The Exchange

Whole Foods Market (WFM) was selling off Thursday as a modestly disappointing projection prompted a panicked reaction regarding the grocer's growth, which is being called into question as it fights the stoutest enemy of all -- itself.

Shares of the Austin, Texas-based chain, known for organic foods and its stance against artificial flavors, slumped as much as 8.3% to $50.88 in recent trading on word the top end of its sales goal probably wouldn't be achieved this year. The selling had conviction, with volume roughly four times that of a normal full day only two hours into the session.

Whole Foods has definitely had some stumbles. But the magnitude of the takedown may be harsh, all things considered.

As for the numbers: The company's top line will likely expand 11% to 12% in fiscal 2014, down a bit from the 11% to 13% range it had foreseen. Whole Foods simultaneously lowered the high side of its comparable-store growth prediction, saying the metric will be up 5.5% to 6.2% this year, rather than between 5.5% and 7%. Earnings should be $1.58 to $1.65, whereas the prior band was $1.65 to $1.69.

Particularly bad here is that those had already been cut, with sales growth previously seen at 12% to 14% and earnings at $1.69 to $1.72 until a recent outlook paring. In the past few years, revenue has generally been up 12.6%, so it's easy to see why anything under that would make a stockholder cross.

It's a state of mind

But let's look at what Whole Foods is, fundamentally it's a state of mind as much as anything. Regular customers adore it, and they're willing to pay the sometimes premium price it puts on scallops and vegetables. It very much enjoys telling the story of its highly regarded work environment and above-average pay for staff. Frequent shoppers embrace the attentiveness to social values. As long as they can afford it, they will.

That said, the prospect of keeping prices within reach is in fact part of the problem for the company's financials, as gross margins are probably set to contract. Competition for consumer dollars obviously exists. Co-founder and co-CEO John Mackey framed it this way during a conference call: "It’s true there is a little bit more competition out there now, but the market opportunity is so much greater than it used to be."

As to the first point, that's undoubtedly fair. Sprouts (SFM) is the new kid on the block, while the big players such as Safeway (SWY) and Kroger (KR) certainly offer cheaper replacement options for at least some Whole Foods products. To the second, that's also true. We're in an age in which better-for-you food is discussed daily, whether at Chipotle (CMG), on TV or in Washington and even at McDonald's (MCD). Worker pay, and what's enough, is another hot topic for progressives. On both these fronts, Whole Foods is already in the sweet spot.

Two realities

This is one of many instances with public companies in which we see two realities the one traders inhabit, and the one in which businesses operate. Sales at Whole Foods have in fact missed expectations slightly in five straight quarters, including the first quarter it reported after the close Wednesday, despite climbing each time. The $4.24 billion it recorded, while an all-time high that rose 9.9% from last year, was shy of the $4.29 billion consensus. Same-store sales, up 5.4%, and earnings of 42 cents also came in light. The bottom line shortfall indeed was notable since, if you look back as far as the second quarter of 2009, there aren't any others. Hardly a horrible showing, but again, with what Whole Foods has been known for, this type of report is intolerable to investors.

The drop in Whole Foods calls to mind a similar slump in natural food seller Hain Celestial (HAIN), which, although not a store operator, is part of the same health and lifestyle group. Both have run up sharply, and, as would be expected, there aren't any excuses traders find suitable for a growth rate downturn. (More broadly, it's been a bad time for food this week: On Tuesday, ConAgra (CAG), Dean Foods (DF) and Annie's (BNNY) all skidded following financial reports.) Amid this decline, Whole Foods is now trading right in line with its five-year average forward price-to-earnings ratio, as well as the price/earnings-to-growth historicals.

As a company, Whole Foods is fine. As a stock, it has run off track, and that's gotten shorts very interested. Over the past year, their position has nearly tripled, and, considering they still represent less than 3% of the stock's float, more may be coming. That's been smart lately, with the stock down 8.2% in the past six months against the 7.4% rise in the S&P 500 over the same time frame. Year to date, Whole Foods has lost nearly 12%. Earnings haven't been kind. In five of the past six quarters, shares have dropped after the report.

So more scaled-back expectations might be what it needs. This is a three-decade-old retailer that still has less than 400 stores. For comparison, Kroger has six times that many. Assuming the trend toward healthier living stays with us, Whole Foods isn't going to struggle to get people in the aisles or find real estate for its brand. But whether that will be enough for investors is another story.