DCF: balance sheet not strong. BB rating from S&P. On the longer term an improvement in margins and/or a better Capex/Revenue conversion is necessary to counter a further deterioration of the credit metrics. The like-for-like revenue growth is negative at the moment, so it’s hard to expect a Capex/Revenue conversion improvement in the short term.

In the end of the DCF sheet we have added some lines regarding the Capex/Revenue developments in historic and future perspective (our assessment). This is interesting because Capex was an important driver for revenue growth in the past (Capex/Depreciation>1) because of new store openings. Because of the negative like-for-like development, the macro environment and the credit metrics, it’s likely (necessary) that Whole Foods will become a bit less aggressive regarding it’s expansion plans. So therefore the future average of capex/depreciation could decrease from 2,2 to 1,8.  Because of the negative like-for-like development the capex growth/revenue growth will deteriorate (from 0,9 to 1,2): more money results in less growth.

ROIC-WACC spread not too comfortable for the short term. This is because the margins take a step back.

WACC: high yield debt at 11% because of BB rating. Please ignore this items history. With current balance sheet prospects we don’t see why this yield should be lower in the future, ceteris paribus external influences on the yield of non-investment grade titles.
Market risk premium a high 8%. Sector beta of 0.8.

SIMULATION: comparing history and future (last lines) from the DCF and WACC sheets: we are very conservative regarding the market risk premium (8%) and the prospects for revenue growth (regarding the past). We are a bit conservative regarding the future margins. The simulation (the numbers representing the averages for the column items for the next 10 years, that is excluding perpetual) shows scenario’s with interesting upward potential regarding the target price: see sensitivity analysis.

SENSITIVITY: Whole Foods has become sensitive regarding the margins because of the low ROIC-WACC spread. A 100bp improvement (over a 10yr future period) results in a 36% price stimulus. Also, an improvement in the market risk premium will result in a significant stimulus.

All in all we are not very surprised by the current stock price of Whole Foods. Nevertheless, there is room (not very unlikely scenario’s) for improvement, of which more than half depends on the company itself and the rest on the normalization of the market risk premium.

disclaimer

the author has no position in this stock at the moment of publishing