Wild Growth for Whole Foods?

Is Whole Foods (Nasdaq: WFMI  ) CEO John Mackey smiling? Perhaps. After offering $565 million for Wild Oats (Nasdaq: OATS  ) in February, the ailing Colorado-based natural grocer Mackey's seeking to buy reported a 70% increase in adjusted per-share earnings last week.

"Adjusted" is the key word there. Wild Oats says it spent $3.5 million in conjunction with the pending merger. Include that and other charges related to restructuring in the tally, and per-share net income falls by 44%.

Still, management deserves some credit for boosting efficiency. Revenue improved by 4%, though Wild Oats had two fewer stores in its chain by the end of the reporting period. Mackey -- a stickler for efficiency in his own operation -- would be proud.

But plenty of problems remain, particularly comps. Same-store sales improved just 0.3%, versus 4% the year prior. Further competition in organics from Whole Foods, as well as classic grocers such as Safeway (NYSE: SWY  ) and Kroger (NYSE: KR  ) , must be at least partly to blame.

Wild Oats' response, alas, is even more troubling than the threat itself. In explaining a decline in gross margin, management said that the grocer is stocking lower-margin merchandise and beefing up promotions. That's a far cry from the strategy that has earned Whole Foods the nickname "Whole Paycheck."

It's also sure to affect free cash flow, which is already suffering from higher capital expenditures earmarked for expansion and remodeling, including the ongoing construction of a flagship store in Boulder.

But that may be just the beginning. Mackey has promised to boost the output of some Wild Oats locations by 50% to 70% within two years. There are only two ways to produce that sort of growth: bulk up inventory or raise prices. Either way, additional capital investment seems inevitable.

Wild Oats isn't yet a business to smile about, not even for the permanently sunny Mackey. But if interim CEO Greg Mays and his team continue to produce more with less, this promised organic oligopoly could cook up tasty returns for investors.

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Fool contributor Tim Beyers, who is ranked 6,458 out of more than 28,400 in CAPS, likes his food and his stocks organically delicious. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. All of his portfolio holdings can be found at Tim's Fool profile. His thoughts on Foolishness and investing may be found in his blog. The Motley Fool's disclosure policy is like bran for your portfolio.

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