Monday, March 21, 2005

Went short on OATS today

Wild Oats Markets (OATS) has been on a tear of late. In the last month, the stock has gone from around 6 to over 9 today (intraday). Much of this move can be attributed to two analyst upgrades, one from Prudential and another from KeyBanc. These upgrades also probably forced a good deal of short covering (short interest 10%+). I went short in the 8.80's today. Here is why I feel there is more downside than up at the current level:

  • Whole Foods (WFMI) shows no signs of letting up. According to WFMI management, their are 26 new WF stores in the pipeline that will compete directly with OATS. Even OATS longs can't argue with the fact that WFMI is the industry star. Gross margin is approx. 700 basis points better at WFMI and in Q4'04, SSS were up 11% at WFMI and down 3% at OATS.

  • What about Kroger or Albertson’s or WMT or TGT? I can’t speak to specifics here, but with natural foods growing at a decent clip, surely they’ll dedicate some shelf space in this direction.

  • Even though comps were down 3% in Q4 for OATS, that was better than analysts had forecasted (-5-6%) and Prudential is pointing to stronger sales growth ahead. But the key of course, is not sales growth, but profitable sales growth. Even though OATS grew the top line at a greater rate than expectations, GM declined 202bp and EBIT margins declined 263bp (to -1.7% of sales) YOY.

  • OATS has continued to revise lower its forecasts for new stores in 2005. At one point, the number was 25. Then it was revised down to 15. Now it stands at 12. I know that WFMI is anxious to go head to head and Trader Joe’s is no slouch either. I’m not sure that OATS has the balance sheet to really improve/enhance their store base. At the end of 2004, their adjusted leverage ratio (net debt to EBITDA including operating leases) stood at 5.19, pretty close to the covenant of 5.6.

  • One thing that OATS is focusing on that makes sense is private label. OATS management wants to take it’s PL percentage of total sales up from 12% to 20%. This must be beneficial to margins.

  • One chance that OATS is taking that I am betting will fail is it’s aim to add more conventional items to its product mix to try and reduce 2nd trips that it’s customers have to make (to a drug store, supermarket). This is a fine line for OATS to walk. What are you trying to be, a health food retailer or a supermarket?

  • I don’t believe in management. What is the strategy? The company operates two store formats, Wild Oats and Henry’s Farmer’s Market. Why? In the Q2/3 cc, management was excited about HFM expansion opportunities. HFM was hardly mentioned in the Q4 cc. Now the talk is on conventional items. AHH has mentioned that the HFM stores are facing increased competition from traditional super markets who are trying to recapture market share in CA following the strike there last year. The foul-ups regarding the Tree of Life/UNFI distribution situation also give me pause.

  • Another part to the share price rise is takeover chatter that kind of bounces around this name. Yes, there is a lot of M&A activity right now but why would someone want OATS with such horrible locations? And at what price? FWIW, an analyst at King thinks a buyout by someone like Kroger won’t happen because KR would have to unionize the OATS store base making them even more un-competitive with WFMI and T Joes.


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