Whole Foods’ (WFM) recent earnings report highlighted the competitive landscape of the organic food industry. The barriers of entry are becoming less evident as more organic grocers are opening. Not only are there more specialty food stores, but organic foods are increasing their presence in conventional supermarkets.
United Natural Foods (UNFI) is a way to have a stake in Whole Foods and help alleviate the risk of competing conventional supermarkets. United Natural Foods is the largest distributor of natural, organic and specialty foods in North America with 28 distribution centers in the U.S. and Canada. Its closest competition, KeHE Distributors, is half of its size. United Natural Foods offers more than 65,000 products consisting of national brands, regional brands and private label products. They serve more than 31,000 customer locations including independently owned natural products retailers, Whole Foods, and conventional supermarkets. The company uses the term “supernatural markets” in its SEC reports when it comes to large, organic grocers, but Whole Foods is its only customer in that category.
Whole Foods is the No. 1 customer of United Natural Foods. Thirty-six percent of UNFI’s sales went to Whole Foods. They have been Whole Foods’ primary distributor for more than 15 years and will continue to be until at least September of 2020. A distribution agreement was set to expire in 2013, but it was extended three years in advance in 2010. There is a risk with Whole Foods accounting for over a third of its sales, but it is also a positive because Whole Foods will be a stable customer over at least the next six years. Whole Foods currently has 379 stores, expects to have 500 stores by 2017, and see demand for 1,200 Whole Foods stores in the U.S. While participating in the growth of Whole Foods, United Natural Foods is supplying other large grocers such as Safeway, Kroger, Costco, ShopRite and Giant Eagle. It is also expanding into foodservice with Sodexo, Aramark and Compass Group.
The company has a long-term goal to expand sales by 10 percen tto 15 percent per year, similar to its historic growth rate. Another goal is an annual increase of operating margin of 9 to 12 basis points. For the most recent quarter operating margin was at 2.97 percent. A 10 basis point increase would add 3.3 percent to the bottom line.
United Natural Foods is in the process of rolling out a national warehouse management and procurement system to promote operational efficiencies and further reduce operational expenses to offset lower gross margins expected from increase sales to Whole Foods and conventional supermarket chains. Complete rollout is expected by 2017. With an increase in sales and operating margin, the company can grow at annual rate of 15 percent.
Financially, United Natural Foods is very strong. The company scores an 8/10 for Financial Strength. It has a low debt-to-equity ratio of 0.24. Although the company holds a small amount of cash, its operating earnings are large enough to cover its interest payments 31.46 times. The company also has an Altman Z-Score of 7.16. A score higher than 2.99 indicates a safe level of debt.
A negative about the company is that shares outstanding have been increasing every year for at least the past 10 years. The long-term increase has been low at a rate 2.19 percent per year, but I would like to see the dilution stop at some point.
With Whole Foods gaining more competition from conventional supermarkets, I think the better investment is to go with the company that supplies both of them. Two gurus we follow at GuruFocus have trading patterns that would coincide with the idea. Steven Cohen and Ken Fisher have both been reducing their Whole Foods positions and have had increases in their United Natural Foods position.
Steven Cohen's WFM Holding History
Steven Cohen's UNFI Holding History
Ken Fisher's WFM Holding History
Ken Fisher's UNFI Holding History
United Natural Foods is no bargain at its current price of $66.94, but it is fairly valued and comes with lower risk than Whole Foods. The company is fairly valued based on its historical valuation, growth, and low volatility. Its stock is now trading in line with its 3-year median P/E of 27.8. Based on its future 15 percent growth rate and low beta of 0.65, the GuruFocus DCF Calculator gives a fair value of $65.33. For a play in the natural and organic food industry, United Natural Foods could be the one to go with.
