Today Wal-Mart (NYSE:WMT) announced a new partnership with an organic food supplier called Wild Oats, LLC. Wal-Mart will sell 100 Wild Oats-brand pantry items at 2,000 of its locations. According to Wal Mart's Executive VP of Grocery "customers will be able to purchase organic items at non-organic prices". Does Wal-Mart's new partnership mean investors in Whole Foods (NASDAQ:WFM) should run for the hills?
Good for Wal-Mart
The partnership may be good for Wal-Mart. Offering affordable organic products could bring new customers to the massive retailer famous for competing on price.
Wal-Mart did its research before sealing the deal with Wild Oats. An internal study found that 91% of Wal-Mart customers would consider purchasing affordable organic products at its stores.
Organic and non-organic products are substitute goods i.e. people usually buy one or the other. Since the new organic products will be comparably priced to Wal-Mart's non-organic items, it's safe to assume Wal-Mart believes the partnership will attract new customers to its stores.
Bad for Whole Foods
It appears the organic lifestyle, once considered outlandish, is quickly becoming mainstream. According to the industry tracker Penton, the organic industry is poised to grow 50% by 2018--a trend that may help Whole Foods grow its earnings.
While pioneering the organic market in the United States, Whole Foods has enjoyed juicy margins compared to its non-organic counterparts. But if Wal-Mart continues expanding its selection of cheap organic products, Whole Foods may be forced to lower prices or lose customers to Wal-Mart.
Whole Foods currently has a price-to-earnings ratio of 34.45 times trailing earnings. That's nearly twice the P/E ratio of the S&P 500 This suggests that Whole Foods investors anticipate significant earnings growth for the organic retailer.
If Whole Foods is forced to slash prices, its earnings and stock price may suffer.
So, should Whole Foods investors panic?
At this point, it's difficult to predict how the partnership will affect Whole Foods. But it's probably safe to assume that the executives at Wal-Mart know what they're doing. They wouldn't have forged the partnership if they weren't confident the deal would bring in new customers. It just so happens that a lot of the market share targeted by Wal-Mart currently belongs to Whole Foods.
Some believe the deal will have no effect on the profitability of Whole Foods. They argue that organic eating is a way of life not a shopping decision. Although there is some validity to their argument, it's hard to believe Wal-Mart's efforts won't have some effect on Whole Foods.