A healthy lifestyle is becoming all the rage, and the trend has led to an increase in demand for natural and organic foods.
Along those lines, there has been a lot of success in the organic grocery retail space. Whole Foods Market (Nasdaq: WFM) is up nearly fivefold over the past five years. There's also been a rise in competition, such as Sprouts Farmers Market (Nasdaq: SFM), which had its IPO last year.
In this case, rather than buying shares of Whole Foods, or trying to guess which grocer will have the most success in the industry, investors might be best served by investing in the company that sells the natural and organic products grocers stock their shelves with.
The best choice here is United Natural Foods (Nasdaq: UNFI), which is the top distributor of natural and organic foods in the U.S.
Upside In Organics
A couple of years ago, the Organic Trade Association found that 80% of families buy at least some organic food -- but organic foods account for only 4% of total food sales.
The trend toward organic and natural foods is still in the early stages. But more people are becoming concerned with what they put in their fridge and on the dinner table. You can see evidence of this in United Natural Foods' strong results lately.
Last month, United Natural said earnings in its fiscal second quarter were up over 20% year over year. Management also boosted its earnings outlook, expecting earnings per share (EPS) of $2.45 to $2.51 this fiscal year, a 12% to 15% year-over-year increase.
|Last quarter, sales to conventional supermarkets were up 15% year over year and now account for 26% of United Natural's total sales.|
Supermarkets such as Kroger (NYSE: KR) and Safeway (NYSE: SWY) are also taking a greater interest in natural and organic foods. Last quarter, sales to conventional supermarkets were up 15% year over year and now account for 26% of United Natural's total sales.
United Natural also sells to food-service and catering companies, which are increasing their demand as they look to serve more health-conscious diners. United Natural's food-service division saw sales up 28% last quarter from the same period the previous year.
Internal Strengths Drive Margin Expansion
The beauty of United Natural's business model is the size and scale of its operations. The company distributes more than 65,000 products through its growing national network.
Beyond just growth in the industry, United Natural can improve its operational efficiencies. During the fourth quarter, the company opened two new distribution centers and plans to add several more this year to the more than two dozen it already has. That should help streamline operations and improve overall efficiency.
While the stock trades at a price-to-earnings (P/E) ratio of 29, this is still below its major competitor Hain Celestial (Nasdaq: HAIN) at 32. Meanwhile, United Natural Foods has a better balance sheet, with a debt-to-equity ratio that's half of Hain Celestial's.
And although the P/E might seem high compared with other food distributors, the key for United Natural Foods is that it operates in a faster-growing segment than conventional foods. It also has a competitive advantage thanks to its vast infrastructure, which also gives it an economic moat. This means it would take a lot of time and capital for a competitor to build up a network like that of United Natural Foods.
Risks to Consider: United Natural Foods relies on Whole Foods for about 35% of its business. But United Natural has been Whole Foods' main distributor for over a decade, and the two have an agreement that lasts until 2020. Further, the continued rise of conventional supermarkets as customers, which involves lower-margin sales, could pressure margins over the long term.
Action to Take --> In the case of organic and natural foods, investors should be buying the shovel makers, not the shovels. Buy the top organic food supplier, United Natural Foods, for close to 10% upside to $79.