UNFI - United Natural Foods: Another Serious Disappointment Raises Concerns

2023-09-28 05:31:54 ET

Summary

• United Natural Foods shares have dropped due to concerns about the future of the business and a shocking earnings shortfall.
• UNFI's 2024 guidance is soft, with significant margin pressure expected, leading to increased leverage ratios.
• The poor guidance and lack of profitability have caused investors to be cautious and avoid getting involved with the company's shares.

Shares of United Natural Foods ( UNFI ) have seen another leg lower, as investors fear for the future of the business. On the final day of June, I believed that United Natural Foods announced a shocking earnings shortfall, marking huge shareholder value destruction.

That setback was big enough as it is, making that some leverage concerns arose, but moreover it is the 2024 guidance which is quite soft, with further and significant margin pressure seen. This will eliminate all the (adjusted) earnings power and quickly increase leverage ratios, making me very cautious to get involved.

A Quick Recap

In the 2010s, United Natural Foods was a darling among investors as the natural foods distributor often announced bolt-on deals and delivered on solid organic growth, with investors sending shares to a peak around the $80 mark in 2018.

At the time the company generated $10 billion in sales from distributing healthier and organic foods, with EBITDA margins reported at 3% and change. The investment thesis changed in its entirety in 2018 as the company acquired SuperValu in a $3 billion deal. The supermarket chain (and distributor) was a different business, adding $15.6 billion in annual sales and about $400 million in EBITDA.

The pro forma business was set to generate $25 billion in revenues, $700 million in EBITDA (and $900 million post synergies), badly needed as leverage was sky-high with net debt reported at $3.3 billion. On the other hand, pro forma earnings of around $4 per share looked compelling.

Pre-pandemic shares fell to the mid single digits as debt weighed on the business, but the pandemic provided a boom to the business with shares rising to the $50 mark in 2021. This came as results for the year ending July 2021 rose to $27.0 billion with EBITDA reported at $770 million, as revenues rose to $28.9 billion in 2022 while EBITDA rose to $829 million, with earnings reported at $4.83 per share.

The company guided for modest growth in 2023, with sales (originally) seen up to $30 billion and EBITDA up to $865 million, as earnings were seen at $5 per share as net debt was down to $2.1 billion, for a 2.6 times leverage ratio.

With food inflation moderating the company saw real pressure on margins. After hiking the full year sales guidance to $30.3 billion alongside the first quarter earnings release, EBITDA fell some $115 million to $750 million. Following the third quarter earnings release, the company cut the EBITDA guidance further to $630 million, with earnings now seen at $2.05 per share. The revised guidance implicitly implied that EBITDA would fall below the $100 million mark in the fourth quarter, looking very soft.

With 60 million shares trading at $20, the equity valuation came in at $1.2 billion, for a $3.2 billion enterprise valuation if we factor in net debt of $2 billion, which incidentally is the same as the purchase price of SuperValu some five years ago, as a testament of the value destruction. With shares down to $50 and the equity valuation being notably lower, I was not yet ready to buy the dip.

Another Shortfall

With shares of United Natural Foods trading around the $20 mark over the summer, shares fell to $13 and change overnight as the fourth quarter results marked the latest huge shortfall.

Fourth quarter sales rose 2.0% to $7.4 billion, yet adjusted EBITDA was more than cut in half to $93 million. The company posted a GAAP loss of $68 million, equal to $1.15 per share based on GAAP accounting as adjusted losses came in at $0.25 per share. This made that full year sales rose 5% to $30.3 billion, with EBITDA down 23% to $640 million, as adjusted earnings of $2.23 per share were more than cut in half compared to the original guidance. The only good news was that net debt fell just below the $2.0 billion mark amidst solid cash flow generation.

The problem is that the fiscal 2024 guidance is utterly soft. While sales are seen up in a modest fashion to $30.9-$31.5 billion, yet the issue is that of continued pressure on earnings. Adjusted EBITDA is seen down to $450-$550 million with the bottom line expected to come in anywhere between an adjusted loss of $0.38 per share and profits of $0.88 per share.

This lack of profitability means that net debt will no longer come down, as realization of such EBITDA makes that leverage ratios will improve from 3 times to 4 times, assuming the midpoint of the EBITDA guidance will be achieved. This is an utter disappointment as the company targets further synergies related to the SuperValu deal.

What Now?

The outlook for the coming year is utterly disappointing with adjusted EBITDA seen down another $140 million from 2022, creating a more than $2 per share headwind on the bottom line. The issue is that the headwinds come from the SuperValu deal, as well as the incurred leverage, as the core of natural distribution food business in theory should be interesting.

With leverage concerns mounting on the back of the poor guidance for the year, and the elimination of all the remaining profitability, I understand why investors are very cautious here. I have absolutely zero interest in trying to become the hero here and get involved with the shares of United Natural Foods, as plenty of more work needs to be done.

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