Claiming that its weak third-quarter results were an "aberration" that is largely due to the long-lingering effects of the Southern California strike, Wild Oats' (NASDAQ:OATS) management hoped to convince analysts on its quarterly earnings call yesterday that its underlying business remains strong. If management is right, there's a strong case to be made that the stock, which has fallen significantly in recent months, could be a real bargain.
The problem is that the long-term competitive advantage of the business model is questionable. Two fundamental strategic issues particularly stand out to me.
The first issue is focus and consistency. The company operates about 100 stores under at least four different formats: Wild Oats Natural Marketplace, Henry's Farmers Market, Sun Harvest Farm, and Capers Community Market. Critical to success in retail is execution, and it is hard to imagine how the company can optimize processes across these different brands and formats. In addition, the company is further diluting management's focus by pursuing other, marginal strategies -- sales through Internet grocer Peapod and a store-within-a-store concept with Stop & Shop.
The second fundamental issue is customer selection and the value proposition to those customers. Industry leader Whole Foods (NASDAQ:WFMI) has positioned itself with high-end, gourmet customers. It has a clearly differentiated offering for those customers, which results in significant pricing power and gross profit margins of more than 34%. In contrast, Wild Oats claims that it is targeting a more mainstream shopper who also shops in traditional grocery stores and discount stores such as Costco (NASDAQ:COST) and is attracted by the natural foods and produce at Wild Oats.
As I have argued, this mainstream shopper is under attack -- from one side by gourmet stores such as Whole Foods and local specialty stores, and from the other side from Costco, Wal-Mart (NYSE:WMT), and Target (NYSE:TGT). Traditional grocery stores are fighting tooth and nail to hang on to their customers by discounting heavily, particularly in Southern California. As a result, prices and gross margins are being squeezed. Wild Oats' gross margin for the quarter was a weak 27.5% of sales. Not only is that much weaker than Whole Foods' margin, but it is also below gross margins reported by traditional grocers such as Safeway (NYSE:SWY), which most recently posted gross margins of 29%.
In addition, both traditional grocery stores and discounters are increasing their offerings of natural foods and organic produce. Unless Wild Oats focuses on a niche customer segment and is able to provide it with a differentiated offering, its strategy is unlikely to succeed.
Although management thinks that recent results are due to short-term factors, I'm unconvinced that Wild Oats has a business model that will win over the long term. Until the company addresses a couple of fundamental issues, the stock remains a risk.
For related Fool analysis, see:
- Wild Oats Grows Stale
- Is Whole Foods Overvalued?
- Skeptical of Safeway's Spin
- Whole Foods' Wild Move
- Wild Oats' Organic Growth
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Fool contributor Salim Haji lives in Denver and owns shares of Costco and Whole Foods. He does not own shares in any of the other companies mentioned.
