March 4, 2016
United Natural Foods is a cheap, undervalued company that could outperform as the natural food industry grows.
A hundred years from now, people will look back on the current industrial food era with amazement, wondering, “Why were people so ignorant about the health risks of eating industrial food?” Processed food, food additives, and GMOs have turned the simple process of eating a family meal into a health hazard.
Consumers, to their credit, are increasingly aware that better living when it comes to food is not found through chemistry and bioengineering. They’re turning to natural foods, and they’re turning away from food with chemical ingredients and GMOs. The trend’s been going on for decades, but low penetration levels suggest that there’s a lot more room to run.
Natural foods, with less than a 10% share of the overall grocery market, are driving more than two-thirds of grocery growth. Consumers are looking for food that’s environmentally sustainable, healthy, and transparently labelled. As a result, new natural food stores are being built everywhere while conventional grocery and drug chains are creating or expanding their own natural food sections.
The 25 largest food and beverage brands have been losing market share to small natural product brands for years, and they’re frantically adjusting their product formulations. As Denise Morrison, CEO of Campbell Soup, admitted “We are well aware of mounting distrust of Big Food.”
We’ve been reluctant to invest in this trend, because until recently most of the companies involved in the natural food industry have been too expensive. United Natural Foods (UNFI), the leading distributor of natural products, has seen a share price decline of 60% over the past year, and it’s currently trading at a share price that it first reached in 2005, more than ten years ago.
The reasons for investor pessimism are two-fold. First, UNFI’s largest customer, Whole Foods, is facing more competition, causing its own sales growth to slow. Second, UNFI recently lost another large customer, Albertsons, to a competitor. Our belief is that the Albertsons account was not particularly profitable for UNFI, and it is likely even less profitable for the competitor.
In our view, the first issue is manageable and the second issue is temporary. Certainly, Whole Foods is facing increased competition. But most of its competitors still rely on a distributor to help them manage their supply chain. With Albertsons, UNFI has a temporary capacity utilization problem that it will fix as UNFI finds new customers, and as consumer demand for its distributed products continues to grow. In the fourth quarter, underlying organic growth, ex-Albertsons, was 6.5%.
We expect challenging sales and earnings comparisons during the next few quarters due to the Albertsons loss. Meanwhile, investor uncertainty around near-term sales and earnings has created what we believe to be an attractive buying opportunity for long-term investors. UNFI, in our view, is a well-run, responsibly managed growth company with a value share price.
At the moment, UNFI is trading at a multiple of sales and at a multiple of operating income that represents a 15-year low for the stock. Given the multiple that investors are paying for low-growth or no-growth food stocks, we find this remarkable. Moreover, the CEO and COO of UNFI purchased over $500,000 worth of UNFI shares for their own accounts at materially higher prices than the current UNFI share price.
We estimate that the company’s intrinsic value is considerably higher than the current share price reflects, providing us with an ample margin of safety relative to the current share price. In a stock market searching for direction, we are glad to own a high quality company like UNFI with an undemanding valuation.
Investing involves risk. The information contained herein is neither investment advice nor a legal opinion. The views expressed are those of the authors as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Pekin Singer cannot assure that the investment discussed herein will outperform any other investment in the future. Past performance is no guarantee of future results.