DGI Adventure – 10-26-2015 Investment Thesis – Whole Foods Market Inc. (WFM) – $XX.xx/share?

Dividend Cycle

WFM will likely go ex-dividend
sometime in mid January (1/14/16 – 1/16/16 timeframe). There’s a good chance
management will announce a dividend increase from the current $0.13/share
quarterly dividend. WFM is just starting to establish itself as a dividend
grower. It is currently a dividend challenger on David Fish’s CCC
(Champions, Contenders and Challengers) list
, having raised its dividend 5
consecutive years. The most recent increase was an 8.3% raise. Previous
increases were double digit percentage raises. The company cut its dividend in
the midst of the financial crisis (2H 2008) and didn’t reinstate it until 2011.


My wife is looking to make 4
purchases with her 2015 ROTH IRA contribution of $5,500. The other three
choices have been made and limit orders are lying in wait. This fourth purchase
should be roughly $1,500. The exact number of shares at what price remains to
be determined.

The QC (Quantitative Case)


*NOTES: 5 year average Yield is
not available on Morningstar. Since they just got to 5 consecutive years of
paying a dividend (raising it each of those years) I guess the 5 year average
yield isn’t an available statistic. Considering the last time WFM shares traded
hands at this price was August of 2011, it’s probably safe to say the current
yield is also pretty good compared to whatever the 5 year average might be.

LOL (Limit Order Logic) – $XX.xx/share

I could probably come up with a
fair value estimate closer to the current share price than $26.00/share by
using a multi stage DDM model, but honestly I don’t feel like it, and I don’t
really like those anyway. I have to constantly remind myself that the DDM is a
made up number based on major assumptions, minor changes to which create
massive swings in the output. From a pure DDM valuation, WFM is overvalued, because
WFM pays a relatively small dividend (current market yield is only 1.7%). It is
not really a dividend growth stock…yet. They are just now establishing a track
record of dividend growth.

That said, their cash flow
situation is fantastic. They have virtually zero debt. The Dividend Cushion
Ratio calculation was based on 2014 numbers. TTM numbers look a little better,
and the share price’s recent poor performance is likely more a reflection of
Mr. Market wanting to see astronomical growth as opposed to the current growth.
There’s still growth. They can easily raise the dividend well above the 8% mark
for the next several years and simultaneously afford the capex needed to grow
the business.

The next earnings release is November 4th,
2015. The last one didn’t go too well. There are some very old 2011 support
levels in the $27 – $28 range which represent another 10% (ish) drop in share
price. A 5 year chart:


Mr. Market is pretty sour on WFM
at the moment. But Mr. Market is also bat shit crazy and can change his mind at
any minute. Next earnings could go either way, and we all know the actual
numbers don’t matter that much. He could continue to hate WFM or he could
decide they’re his new best friend. Either that chart above is showing us a “double
top” and Whole Foods is starting a death spiral…

…or the correction from the
October 2013 peak is about over.

A log scale chart spanning WFM’s
entire history as a public company:


QWaF (Qualitative Warm and Fuzzy)

My wife works for a restaurant
supply company. Part of their business involves providing and installing
commercial kitchen equipment. A surprising number of well-known companies are
big customers. Here in the San Francisco Bay Area, the big-name tech companies
put in some ridiculous cafeterias and supporting commercial kitchens for their
employees (think Google, Apple, Twitter, Facebook, Square, etc.) We half-jokingly
came up with an investment strategy involving companies that spend a lot of
money on commercial kitchens. Zynga might be the one outlier, but in general it’s
not as crazy as it initially sounded. A company that has enough cash to splurge
on an elaborate commercial kitchen to support a company cafeteria is investing
in itself.

Whole Foods’ kitchens aren’t part
of an extravagant employee benefit package. They’re actually a big part of a
store’s profit model. You know the “prepared foods bar”? The one where you end up
inexplicably spending $30 on a take-out box of fried chicken and three bean
salad? They cook that shit on location. Which means they need a commercial
kitchen on location. They’re spending a lot of money on commercial kitchens because
they’re growing.

Whole Foods is the poster child
of the natural/organic food movement. That market is expanding. Whole foods is
growing and gobbling up more than its fair share of the gluten free pie.

CPR (Cold and Prickly Risks)

Other people have noticed the
growth of the natural/organic food market…big rich people with massive market
capitalizations. Whole Foods sells foofy food at an incredibly high price. Wal-Mart,
Target, Safeway and their massively efficient supply chains can probably sell
equally foofy food at much lower prices. That sounds bad for Whole Foods profit
margins. The natural/organic food market is growing rapidly. Can Whole Foods
continue to grow with the market and continue to increase its market share? If
so, they probably need to adapt. The new 365 store format is ostensibly an
adaptation to that changing market environment. But it could be a huge flop.
That is a risk. Increasing competition in the natural foods market is a risk.

For some reason, Whole Foods
locations grow their same store comparison sales really well for the first five
years and then flatten out. Maybe that’s a risk and a problem that Whole Foods
needs to solve. Or maybe after a new Whole Foods store opens up it takes 5
years for anyone who doesn’t want to spend 30 minutes looking for a parking
space just to spend $20 on fried chicken to realize it’s just not for them.

Good thing they’re planning to
triple their store count.

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