Wal-Mart Goes After Whole Foods and Sprouts Farmers Markets

Wal-Mart is increasing its presence in organics with low-cost products. Is it a cause for concern for investors in Whole Foods and Sprouts Farmers Market?

Apr 11, 2014 at 5:05PM

Captura De Pantalla

Source: Wild Oats.

Wal-Mart (NYSE:WMT) announced on Thursday that it will be increasing its presence in natural and organic foods via a partnership with Wild Oats to offer organic products at conveniently low prices. Is this a reason for concern for investors in Whole Foods Market (NASDAQ:WFM) and Sprouts Farmers Market (NASDAQ:SFM)?

Wal-Mart joins the organic revolution
Wall-Mart is relaunching Wild Oats, a line of organic foods that was originally introduced in 1987. Wild Oats was purchased by Whole Foods in 2007. Back then, it was the second-largest organic grocer behind Whole Foods itself, so the deal raised some antitrust concerns, and Whole Foods had to sell in Wild Oats in 2009 because of antitrust regulations. 

Wal-Mart will offer nearly 100 products from Wild Oats selling at a considerable discount to competing alternatives. In the press release regarding the relaunch, Wal-Mart included a table comparing Wild Oat product prices versus similar alternatives, and the price difference is quite substantial. 

Wal-Mart estimates consumers will save nearly 25% on their grocery bill when purchasing organic products from Wild Oats versus other organic products, and this sounds like a smart proposition considering recent industry trends.

Captura De Pantalla

Source: Wal-Mart.

Demand for natural and organic food has been steadily growing over the last several years, yet one of the biggest drawbacks for consumers is the higher price tag that comes with these products. Wal-Mart seems to be moving in the right direction when it comes to analyzing consumer needs and making an effort to meet demands.

Can Wal-Mart succeed?
There is a reason that organic and natural products are typically more expensive: They cost more to produce. Wal-Mart benefits from enormous scale and negotiating power with suppliers, so the company could leverage its strength to achieve some costs savings.

On the other hand, retail margins are notoriously low in the industry. Wal-Mart has a gross margin below 25% and an operating margin in the area of 5.5%, while Sprouts Farmer Market has a gross margin around 30% and an operating margin near 5.7%. Whole Foods, being the quality leader in the industry, generates moderately higher margins in the area of 35.8% and 6.8% at the gross and operating levels, respectively.

Arroyo

Source: Whole Foods Market.

Wal-Mart usually receives plenty of criticism on ethical matters, and its brand does not resonate particularly well among consumers, especially among organics consumers, who are usually more conscious regarding ethical and sustainability standards. The retail giant will probably need to improve its image if its going to succeed in areas like organics in the medium term. 

Still, the company says that it has nearly 1,600 organic grocery items on its shelves, and management claims that internal research is indicating that 91% of its shoppers would buy affordable organic products from Wal-Mart.

It will be hard for Wal-Mart to convince organic food purists to purchase at its stores, even if price can sometimes be a very convincing argument. On the other hand, that does not mean the company can't make some inroads over time, especially considering that many consumers are increasingly paying more attention to the nutritional quality and health implications of the food they consume.

Do Whole Foods and Sprouts Farmers Market need to worry?
Both Whole Foods and Sprouts Farmers Market are facing increased competitive pressure lately, but they are also generating substantial growth for investors in spite of competitive challenges.

Whole Foods delivered lower-than-expected sales and earnings for the quarter ended on Jan. 19. But sales came in at $4.2 billion, a solid 10% increase from the same quarter in the previous year, on the back of a 5.8% increase in same-store sales.  

Whole Foods also reduced its guidance for fiscal 2014: Sales are expected to rise between 11% and 12% versus a previous estimate of 11% to 13%, while same-store sales are expected to grow between 5.5% to 6.2% compared to a prior forecast of 5.5% to 7% growth.

Deceleration is a valid reason for concern, but it's also worth noting that Whole Foods is still delivering growth rates that are materially above those observed in regular grocery stores.

Captura De Pantalla

Source: Sprouts Farmers Market.

Sprouts Farmers Market provided robust guidance for the quarter ended in March. The company expects sales in the area of $720 million during the quarter, a 26% increase versus $573.3 million in the same period of 2013. Comparable-store sales are expected to increase at a remarkable 12.5% during the period. 

Sprouts Farmers Market is materially smaller than Whole Foods, so it's easer for the company to grow more rapidly. Besides, its slogan, "Healthy Living for Less," is quite clear on the fact that Sprouts Farmers Market is willing to offer lower prices in order to compete for market share.

Still, that doesn't change the fact that Sprouts Farmers Market is delivering attractive growth rates in spite of increased competition over time.

Wal-Mart is making a smart move by offering organic products at discounted prices, and the retail giant is certainly a competitor to watch. However, Whole Foods and Sprouts Farmers Market are delivering solid growth rates in spite of increasing competition in the natural and organics category over the last several years. Demand growth is providing enough room for multiple players to succeed, and there is no reason to believe that's going to change anytime soon.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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