Turnaround Tuesday: Sow Wild Oats and Reap Growth

Most investors recognize that turnaround stocks sell at hefty discounts, and that they sell at a discount for a reason, since most companies in turnaround mode are struggling with a series of problems.

The attraction of turnaround investing is obvious enough: To the extent that problems are fixed, the spread will tighten between price of the stock and value of the underlying business. This is what I call "price/value compression," and it represents the main reason why investors gravitate to turnaround stocks.

For example, in a RealMoney.com column in January 2001, I suggested a target fair value of $40 per share for Safeco (SAFC - commentary - Cramer's Take); the stock was then trading at $24, and it currently trades at about $45. The tightening of the spread -- price/value compression -- between price, $24, and value, $40, resulted in a significant gain for buyers of Safeco. But it is short-sighted to single out price/value compression as the only way for turnaround investors to win.

The best turnaround opportunities offer two ways to win. They involve both price/value compression and growth in business value. The latter is often overlooked by turnaround investors, but it is a key component in the most successful turnarounds. Tyco (TYC - commentary - Cramer's Take) is an example of a successful turnaround that has coupled price/value compression with impressive growth -- sufficient to justify a current stock quote, about $30 per share, that is more than three times its 2002 low.

Growth in business value is the only way for investors to win in widely held companies such as General Electric (GE - commentary - Cramer's Take), Microsoft (MSFT - commentary - Cramer's Take) and Wal-Mart (WMT - commentary - Cramer's Take). That's because their stocks trade at prices that approximate the underlying business value. Investors in these stocks are not going to generate gains from price/value compression, because there isn't a significant disparity between price and value.

Turnaround Idea: Wild Oats

Wild Oats Markets (OATS - commentary - Cramer's Take) is a turnaround stock idea where there is potential for both price/value compression and growth in value. The second leading natural foods grocer, behind Whole Foods (WFMI - commentary - Cramer's Take), Wild Oats is beset by a number of operational problems -- all fixable, in my opinion. Here is a look at the five-year price history of the stock:

Looks Tasty Wild Oats Markets is an attractive turnaround candidate.

Source: BigCharts.com

Wild Oats CEO Perry Odak, who effected a turnaround at Ben & Jerry's before selling the company to Unilever (UN - commentary - Cramer's Take), has an ambitious growth plan in place -- a growth plan that is coincident with his turnaround effort.

He plans to double the store base over the next three to four years, to take advantage of the huge market opportunity in natural food retailing.

By my calculations, this company could be generating over $2 billion in annual revenue in three to four years (the current base is $1 billion). While I think the business at Wild Oats is worth more than double the current stock market value of $230 million, the potential for a much higher business value -- predicated on growth in business value --- provides turnaround investors with two ways to win.

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At time of publication, Alsin and/or ACM was long Safeco and Wild Oats, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, TheStreet.com Value Investor.