The world’s largest retailer Wal-Mart (NYSE:WMT) recently partnered with Wild Oats brand to sell organic foods at non-organic prices. The company will be offering a range of pantry staples from Wild Oats priced at least 25% cheaper than other national organic brands and inline with conventional food items. This deal can help Wal-Mart take advantage of soaring demand for organic products in the U.S. as well as revive its stumbling grocery business. The retailer will be launching 100 Wild Oats products ranging from salsa to pasta in 2,000 of its stores in the next few months and will add the brand to its remaining stores at a later stage. 
Although organic food is a small market, it has grown faster than the overall food industry over the past four years. Americans have shown great affinity for these products, despite their premium prices, and they are likely to appreciate the idea of cheaper organic food. This can help Wal-Mart drive greater store traffic and improve its grocery business, which has delivered negative comparable sales over the past four quarters. Grocery sales account for more than 50% of Wal-Mart’s revenues, making it the largest product category for the company.
The organic food space isn’t as developed as the non-organic food industry. Raw material production is low and the supply chain is underdeveloped, which result in higher prices for organic products. Wal-Mart is looking to bring these prices down with long-term purchase agreements with farmers and suppliers, and optimization of supply chain.  This way, the company will be able to offer organic foods at reasonable prices without putting pressure on its margins.
Our price estimate for Wal-Mart stands at $78, which is slightly ahead of the market price.
The Deal Can Help Wal-Mart’s Slipping Grocery Sales
The U.S. retail industry has struggled over the past one year due to weak consumer confidence arising from higher taxes and slow job growth. Even Wal-Mart’s grocery business has felt the impact of a weak macroeconomic environment, which is otherwise resilient to unfavorable economic headwinds. With consumers spending cautiously even on their basic necessities, Wal-Mart has turned its attention to the niche market of organic foods.
With improving lifestyles and growing desire for fitness, U.S. consumers have become extremely health-conscious. Every year, a greater number of people switch to food made from natural ingredients. Back in 2003, about 13% of Americans consumed organic food, which increased to almost 25% in 2013.  The organic food market grew by a healthy 10.2% in 2012 to $29 billion, while it stood at just $8 billion 10 years earlier.  Within the market, packaged organic food sales doubled to $12 billion in 2013 over this time frame, whereas the overall packaged food market grew by just 25% to $360 billion.  Given the rising consumer interest in organic products and the huge addressable market, we believe that the organic food industry will continue to grow at a robust pace.
Considering Wal-Mart’s sheer size, its cheaper organic products and the popularity of Wild Oats, we believe that the retailer will be able to acquire a sizable share of this market. As of 2012, about half of Wal-Mart’s customers shopped for organic foods and an internal survey suggested that about 91% of the retailer’s customers will shop for such products if prices of organic foods are inline with non-organic foods.  Given that Wal-Mart serves close to 100 million customers every week, the Wild Oats deal can garner attention of more than 90 million shoppers. This can have a positive impact on the company’s grocery sales, which contribute more than half to its overall revenues. Moreover, shoppers will easily recognize the Wild Oats brand as it was once the second largest organic food brand in the U.S. and even operated its own stores. 
Why Are Groceries So Important For Wal-Mart?
Consumer spending on groceries can be classified as non-discretionary and is therefore less correlated to macroeconomic factors. During the recession of 2008-2009, consumer spending on food and beverages remained more or less stable, according to economic data from the Bureau of Economic Analysis.  Also, groceries are a big market segment, accounting for annual sales of over $560 billion.  This is a favorable product category for retailers because customers who tend to visit a store to buy groceries are 10 times as likely to visit a pharmacy or a general retail store. This improves cross sell and increases the customer’s overall basket size, which has a positive impact on the retailer’s sales. For example, at Target (NYSE:TGT), which does not have a full-line grocery, stores with a partial-line of groceries in them had higher overall sales than stores without groceries.  This is the reason why Wal-Mart has been focusing on increasing the share of groceries in its overall business.
How Can Wal-Mart Help Develop The Organic Food Space?
The organic food space is highly inefficient at present due to a big difference in demand and supply. According to Clarkson Grain, a licensed grain dealer, U.S. farmers produce around six million bushels of organic soybeans every year, while the current demand requires as much as 20 million bushels. While cost of growing organic grains isn’t necessarily more than growing regular grains, organic soybeans are being sold at twice the price of regular soybeans due to supply shortage. 
We believe that the Wal-Mart-Wild Oats deal is a crucial step towards the development of this industry, which can encourage suppliers to ramp up organic food production and bring prices down. The amount of land dedicated for organic farming has increased over the past few years, which is likely to continue in the future. To procure organic goods at lower prices, Wal-Mart is entering long-term purchase agreements with farmers and suppliers. It is also looking to consolidate middleman to further eliminate unnecessary costs.  These steps will allow Wal-Mart to address its customers’ longing for organic food while abiding by its EDLP strategy.Notes:
- Wal-Mart partners with Wild Oats to roll back prices on organic food, Reuters, Apr 10 2014 [↩] [↩] [↩]
- Walmart to Sell Organic Food, Undercutting Big Brands, The New York Times, Apr 10 2014 [↩] [↩] [↩] [↩]
- Wal-Mart, Wild Oats aim to disrupt the organic food industry, Market Watch, Apr 10 2014 [↩] [↩]
- U.S. Bureau Of Economic Analysis [↩]
- What’s Behind the Rush Into the Low-Margin Grocery Business, CNBC, Jun 6 2013 [↩]
- Big Retailers Fill More Isles With Groceries, The New York Times, Jan 16 2011 [↩]