After Earnings Miss, Wal-Mart Should Buy Whole Foods

| About: Wal-Mart Stores, (WMT)


This move will do exactly what management has tried unsuccessfuly to do the past several years; change the company's image.

Walmart would immediately become synonymous with health and wellness.

The recent consumer shift towards organic and natural foods has created a new growing industry among retailers. Walmart has been relatively shut out, up to this point.

Shares are Wal-Mart (NYSE:WMT) are trading lower this morning following the company's weaker-than-expected first-quarter results. As of this writing, the stock is down almost 2% to $77.21. While the stock traded flat in 2014, shares are down roughly 2% over the past twelve months. The company has been under severe scrutiny.

When the retail giant is not being scorned over low wages for its frontline workers, the company gets hammered for what many believe to be "unfair business practices." Management has not taken these shots lightly. They are working hard to reshape how the retailer perceived. But this morning, all that mattered was how they plan to return the company back to long-term growth - something that is taking a bit longer than they expected.

Following the same theme heard/seen within every sector, Wal-Mart cited the poor winter weather for its downbeat results. Shoppers just couldn't make it to the stores, leading to lower than expected first-quarter profit and revenue. Revenue arrived at $114.2 billion, missing Street estimates of $116.3 billion.

As disappointing as that might appear, it's still roughly a 1% increase year over year. And when you factor in the adverse impact of $1.6 billion from foreign currency exchange fluctuations, the number doesn't appear that bad. Consider, without this impact, revenue would have increased more than 2% to $115.7 billion.

From a profitability standpoint, the company posted a net income of $3.58 billion, or $1.10 per share, which is down 5.1% year over year. With the struggles in revenue, it's not surprising that Wal-Mart missed on the bottom line. Management noted that the weather had an adverse 3 cents per share impact on earnings. Not to mention, the higher-than-expected tax rate.

Comparable store traffic in the U.S. declined 1.4% during the quarter, and same store sales in the U.S declined 1.2%. But that, too, isn't a surprise. But what was a surprise was how well the smaller Neighborhood Market stores continue to perform. Revenue from that segment climbed 5% year over year.

And when you consider where that segment's sales were back in 2012, the fact that they've nearly doubled should erase doubt that this company is unable to grow. Perhaps, more impressive is the fact that this quarter marks the 46 consecutive period that the segment has delivered positive comps. For this performance Doug McMillon, Wal-Mart's president and CEO said:

"Wal-Mart's underlying business is solid, and I'm confident in our long-term strategies. We'll continue to invest in price and enhance our service to improve sales."

In terms of guidance, management said it expects flat comparable store sales in the U.S. The company expects earnings to fall somewhere between $1.15 and $1.25 per share compared to $1.24 per share last year. McMillon also pointed out that Wal-Mart remains steadfast on restoring growth throughout the business and remains committed to the previously-announced Neighborhood Markets initiative and rolling out small stores. The question is, are investors willing to be patient.

That's easier said than done, but I wouldn't rule out the possibility of Wal-Mart going the M&A route to find growth. Recall, two months ago Wal-Mart announced plans to expand its organic food stock. The announcement says that Wal-Mart will offer Wild Oats organic products at a 25% discount. Wal-Mart is looking to enter a space that is dominated by The Fresh Market (NASDAQ:TFM) and Whole Foods (NASDAQ:WFM).

The recent consumer shift towards organic and natural foods has created a new growing industry among retailers. Wal-Mart has been relatively shut out, up to this point. Whole Foods has tried this very same move before: it bought out the Wild Oats chain of stores in 2007. The FTC protested the acquisition under antitrust law, and in 2009 Whole Foods sold Wild Oats under court order. Now Wal-Mart is benefiting from the breakup and from the revived Wild Oats brands.

With shares of Whole Foods having decline 10% of late, it makes since for Wal-Mart to go after Whole Foods before it rebounds. Wal-Mart said it will introduce Wild Oats at roughly 2,000 stores -- half of its national footprint. If the brand gains enough traction, the company will then roll out the product to the rest of the country.

Given the recent earnings growth of smaller players like Natural Grocers (NYSE:NGVC) and Sprout's Farmers Market (NASDAQ:SFM), which have both grown in popularity in a short period of time, there is plenty of profit to made. But from my vantage point, it makes an equal amount of sense to just buy either Whole Foods or one of the smaller players like Sprout's.

But more important than profit, this move will do exactly what management has tried unsuccessfully to do the past several years; change the company's image. Wal-Mart would immediately become synonymous with health and wellness. Who would have thought?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's retail sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.