Editor's Note: This column was originally published as an alert to subscribers to Stocks Under $10 on Dec. 28.As Americans take more notice of their diets, corporate marketing departments are trying to meet their needs. In the past 18 to 24 months, fast-food restaurants like McDonald's ( MCD) have jump-started sales growth by introducing gourmet salads to their otherwise high-calorie menus. Privately held sandwich shop Subway has also seen its popularity boom, with ads proclaiming dramatic weight loss achieved by customers eating its low-fat hoagies. After some research, we believe the healthy-foods name to own in the Under $10 space is Wild Oats ( OATS), and we added 400 shares at around $8.50. The natural foods retailer is third only to Whole Foods Market ( WFMI) and privately owned Trader Joe's in domestic sales. Even though these stores account for less than 10% of all U.S. grocery sales, Katherine DiMatteo, executive director of the Organic Trade Association, said in a Dec. 3 MSNBC.com article that natural foods revenue can more than double from an expected $15 billion in 2005 to $32 billion by 2009. Wild Oats is in the late stages of a turnaround that has seen the divestiture of some high-priced stores that management bought in the '90s, as well as increasing sales of the company's private-label products. Improvements should continue as the retailer targets square-footage growth and increased operating efficiency. We believe it will move into the double digits if management reports two consecutive quarters of solid results. Wild Oats was not always a single-digit stock. In 1999 it was trading in the high $20s, and the retailer used the stock as currency to make a lot of acquisitions. In hindsight, the prior management team overpaid for these deals, and shares fell under $5 by the end of 2000. To get the company back on track in 2000, management began closing or selling underperforming stores, 38 in all according to the latest annual filing with the Securities and Exchange Commission.
In March 2001, Perry Odak took over as president and CEO. He brought with him the reputation of being a turnaround artist, having dramatically improved Ben & Jerry's before selling the brand to Unilever in 2000. Odak wasted no time in laying out a plan to rebuild Wild Oats that includes organically growing Wild Oats' store base to 150 by the end of 2006 from 106 stores today. Last month the company cut back its 2005 new-store plans from 20 to 15, but we believe management will ultimately achieve its goal of having 50% of its store base that is less than five years old by the end of 2006. Another important piece to a successful turnaround at Wild Oats is a rebound in operating margins, which are notoriously thin in grocery retail, usually in the low single-digits. On an annual basis, Wild Oats' operating margins are running at about 1% to 2%, but by 2006, management has a stated goal of moving this number closer to the 4% level it enjoyed a few years ago. We realize that increasing profitability could prove difficult as the company will be spending a lot to build new stores and improve operations, but a recent initiative helped convince us that the company is dedicated to achieving its goal. Wild Oats is working with Stop & Shop stores in the Northeast to test a store-within-a-store concept that would designate a section of the Stop & Shop to higher-margin Wild Oats' branded products. Only one of the 10 analysts who follows Wild Oats has a buy rating on the stock. Given the company's loss of 9 cents a share in 2004, the consensus outlook calls for Wild Oats to earn only 29 cents a share in 2005. Notwithstanding the negative tone of the analyst commentary out there, we believe the company can exceed those full-year estimates if it executes on its strategy.
Wild Oats also rates well in our Alpha Factor, which gauges the potential of a stock to make a large move upward on good news. Any upside to operating margins, earnings per share, or store growth over the coming months could cause some analysts to upgrade Wild Oats. In turn, this would likely cause traders to run to buy back the 12% of the company's shares currently being sold short. Readers need to keep in mind that turnaround stories require a lot of patience and constant monitoring of the company's progress. There have been many potential turnarounds this past year in the Under $10 universe, like Charter Communications ( CHTR), which once seemed on track but then never followed through to gain any momentum. As it stands now, we like Wild Oats' chances of growing its profit over the coming quarters, and believe the stock will move higher accordingly. P.S. Remember, stocks priced under $10 have the potential to move quickly. So, you might want to get our current recommendations now with a free trial to TheStreet.com Stocks Under $10.