Whole Foods Bulls See Healthy Bounce From 28-Month Low: Options

Options traders are betting on a recovery for Whole Foods Market Inc. after disappointing profit growth sent the organic grocer’s shares to an 28-month low.

Calls to buy Whole Foods shares are near the most expensive level since 2007 relative to puts, according to data on three-month options compiled by Bloomberg. The shares have plunged 20 percent since the company reported quarterly earnings last month that fell short of analysts’ estimates for a second straight period.

Once a niche player, Whole Foods spearheaded the expansion of an industry that has become mainstream, Co-Chief Executive Officer John Mackey said on last quarter’s earnings call. To combat mounting competition, the company is now opening new stores and cutting prices on everyday items in an attempt to stay atop the organic and health-conscious food industry.

“Buying the clear market leader in a strong growth category after an earnings hiccup is not a bad strategy,” Howard Ward, chief investment officer for growth equity at Rye, New York-based Gamco Investors Inc., which oversees about $47 billion, said yesterday. “We’re still bullish on the future of Whole Foods.”

Gamco owns Whole Foods shares and added to its holdings following the plunge in the stock after its earnings report, Ward said.

Options Trading

Puts betting on a 10 percent decrease in Whole Foods shares cost 2.6 points more than calls betting on a similar-sized gain, three-month contracts show. The measure known as skew fell to 1.53 points on May 8, the lowest since July 2007. Over the past three years, the calls have been an average of 4.55 points cheaper than puts, data compiled by Bloomberg show.

The two most-owned Whole Foods options contracts are betting the company’s stock will rise. Contracts expiring in January with a strike price of $44 had the highest open interest, followed by bullish bets with an exercise price of $54 expiring in the same month. The shares closed yesterday up 1.8 percent at $38.38.

“It’s a well-recognized name that resonates with people, and the options market is a relatively cheap way to play a stock that’s been absolutely hammered,” Robert Pavlik, the New York-based chief market strategist at Banyan Partners LLC, which manages $4.5 billion, said in a June 3 phone interview. “If you want to be optimistic on the company, options are the way to go.”

Kate Lowery, a spokeswoman for Austin, Texas-based Whole Foods, didn’t comment on the company’s options trading.

Price Cuts

Whole Foods will cut prices to make offerings more appealing to consumers, Mackey said in the post-earnings conference call. The company’s gross margin has increased for five straight fiscal years even amid prior price cuts, leaving room for more reductions.

“We’re going to be investing more aggressively in price going forward, while continuing to take our expenses down and continuing to innovate,” Mackey said.

Whole Foods is facing growing competition from Sprouts Farmers Market Inc. The Phoenix-based grocery store operator is undercutting the prices of its larger rival by about 31 percent for organic produce, according to an analysis by Bloomberg Industries.

A basket of 148 brand-name items, including Kashi cereal, Talenti gelato and Applegate deli turkey, is 13 percent more expensive at Whole Foods compared with Sprouts, according to a study led by Jennifer Bartashus, a Bloomberg Industries analyst in Skillman, New Jersey.

Earnings Growth

Whole Foods will post adjusted earnings-per-share growth of 4 percent in 2014, down from the 49 percent profit increase it saw in 2010, according to data compiled by Bloomberg. The company’s revenue is projected to increase 11 percent this year, compared with 16 percent growth in 2012. Whole Foods has fallen short of analyst sales estimates for the past six quarters.

Whole Foods has “limited upside and significant downside with the intensifying competitive environment,” Mark Dawson, a senior fund manager at Seattle-based Rainier Investment Management, said in a June 3 phone interview. “The real-time metrics of how the sales are performing are below what they had expected, below what many had expected.”

Options investors are undeterred as they look to take advantage of the dip in Whole Foods’s valuations. The company currently trades at 25.6 times earnings, down from seven-year high of 44.2 reached on Oct. 25. The Standard & Poor’s 500 Index’s price-earnings multiple was 17.7 times yesterday.

Price Swings

For the time being, swings in the company’s shares have slowed along with the rest of the market. The Chicago Board Options Exchange Volatility Index, a gauge of options prices known as the VIX, closed 1.8 percent higher yesterday at 12.08. Before that, it had remained below 12 yesterday for seven straight days, the longest stretch since February 2007, data compiled by Bloomberg show. The measure added 0.5 percent to 12.14 at 10:37 a.m. in New York.

“For shares to work higher from here, Whole Foods needs to grind out results, starting with a quarter that is in line with expectations,” Mark Miller, an analyst at William Blair & Co., said in a May 19 summary of a meeting with Whole Foods executives. “This is a scrappy management team that has led this business back from dark days multiple times in the past.”

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