Whole Foods Market, Inc. (WFM): Stock Set For Multiple Expansion

Whole Foods Market, Inc. (NYSE:WFM) shares are set for multiple expansion due to its potential opportunity to gain share as it is a best-in-class retailer with limited credible competition and it continues to narrow the price gap through targeted price investments.

WFM stock gapped up slightly Tuesday and has continued to gain ground. Whole Foods Market has risen past the upper end of a 3-week trading range and has set a new high for the year.

Austin, Texas-based Whole Foods Market, Inc. is the leading natural and organic supermarket in the US and is the first national "Certified Organic" grocery in the country. The company distinguishes itself by offering 2,700 private label stock keeping  units, led by its 365 Everyday Value and 365 Organic brands. The company operates over 350 stores in the US, UK, and Canada and employs over 73,000 non-union Team Members.

WFM could continue to improve its return on invested capital (ROIC) as it should continue to gain share. Strong traffic growth, improvements in shrink and leverage on fixed costs should offset price investments, thus preserving margins. Gross margin for its third quarter increased 61 basis points to 36.6 percent.

"We believe Whole Foods will continue to take share given the company's loyal customer base. It seems clear the company is being well-received in the much smaller, newer markets, including Des Moines and Detroit, specifically," Deutsche Bank analyst Karen Short said in a client note.

ROIC for new stores is improving given more favorable lease rates, stronger openings, and a greater focus on reducing capital expenditures per new store. Average pre-opening expense per store and average pre-opening rent per store have been declining after peaking in fiscal 2009. Both factors are contributing to Whole Foods' improving ROIC.

Free cash flow continues to build, even as unit growth accelerates and this excess cash will be deployed to a higher dividend and/or share repurchase – both of which should be view! ed as positive catalysts.

ROIC trends are highly correlated with stock price performance (0.76 correlation), and WFM's ROIC will continue to improve over time, and the stock should appreciate accordingly.

"Concurrent with improving ROIC, the valuation multiple has expanded, but the relative valuation multiple has not expanded as much – suggesting that further multiple expansion is warranted, in our opinion, as we believe ROIC will continue to expand," Short said.

The company is able to offset price investments through shrink improvements, and these improvements in shrink are coming largely from increased turnover, especially in produce.

For the fourth quarter, the company expects earnings of 30 to 31 cents per share on sales growth of 3 percent to 4 percent. Analysts currently expect earnings of 31 cents per share on sales growth of 5.20 percent.

For fiscal year 2013, the company sees earnings of $1.45 to $1.46 per share and sales are forecast to grow 11 percent. Analysts currently expect earnings of $1.46 per share on sales growth of 11.40 percent.

The stock trades 34 times its 2014 consensus estimate. Profit is expected to grow 16 percent this year and 18.5 percent in the next. The stock has gained 41 percent in the last six months and traded between $40.70 and $60.60 during the past 52-weeks.