UNFI - United Natural Foods: Natural Foods Not Out Of The Woods

2023-03-09 18:06:12 ET

Summary

• United Natural Foods, Inc. has been performing better since the pandemic.
• The hoarding effects of the pandemic came at a time when leverage following the SuperValu deal was nearly bankrupting the business, so Covid-19 provided a lifeline to the business.
• Resulting inflationary pressures since have pushed up margins and profits, allowing for deleveraging ever since.
• With inflationary pressure subsidizing, United Natural Foods profits should take a bit of a beating here as the degree of the earnings shortfall is a bit shocking.

In the final days of 2020, I called United Natural Foods, Inc. ( UNFI ) a risky, yet potentially lucrative play. The company was a beneficiary of the pandemic at the time, as the excess cash flows allowed for debt reduction.

The real financial driver had to come from a potential sale of the retail operations, as there were clear signs on the horizon that the pandemic might be on its retreat following vaccines being taken into production. This all created uncertainty amidst high operating and financial leverage, following an ill-advised M&A move in 2018.

A Recap

In the 2010s, United Natural Foods was really seen as a very valuable consolidator in the market for distribution of healthier and organic foods, playing an active role through M&A, while benefiting from long term tailwinds.

Shares of United Natural Foods, Inc. peaked around $80, as margin pressure hurt the shares a great deal. The company jacked up leverage following an ill-advised and large deal for SuperValu in the summer of 2018, with the deal tag priced at $3 billion. The overhang of debt of this deal meant that shares entered the year 2020 in the single digits as the M&A move had gone terribly wrong, with hoarding effects during the pandemic providing a lifeline for the business.

Going back to 2018, United Natural Foods itself generated about $10 billion in sales and $340 million in EBITDA. The transaction for SuperValu was set to add $15.6 billion in sales and $400 million in EBITDA, albeit that the more asset-intensive nature of SuperValu (with its supermarkets) resulted in larger depreciation charges. Pro forma sales would rise to $25 billion, with EBITDA seen around $700 million (or about $900 million post synergies). Net debt of $3.3 billion translated to a high leverage ratio of around 4.7 times, although earnings power potentially around $4 per share was interesting.

It was very evident that the company was not living up to expectations, as the company initially guided for 2020 sales at $23.9 billion, with adjusted EBITDA seen at $580 million, with both numbers (notably margins) lagging compared to the pro forma numbers at the time of the deal announcement. With D&A being relatively large, adjusted earnings only came in at around $1.50 per share.

With the company having a broken book year, the company posted flattish second quarter sales in 2020. Third quarter sales growth accelerated to 12%, and the company posted strong earnings, as shares rose to $15 (after trading in the low single digits at the start of the year). With the near-term earnings power being strengthened at the time, even as it was clear that earnings power did not look sustainable, it allowed for some necessary debt reduction. Fourth quarter sales growth slowed down to 8%, as the company cut net debt to $2.6 billion, for a 4.0 times leverage ratio.

For 2021, the company guided for earnings of $3.30 per share and $710 million in EBITDA, marking modest growth compared to 2020 (which was only in part impacted by the pandemic). Besides these earnings, to thereby reduce leverage, the company had another wild card by potentially divesting the retail business as well, although there was the issue of being reliant on Whole Foods as well. Hence, I concluded that real execution was required, as that had been lagging for years.

A Boom

A $15 stock late in 2020 rose to the $50 mark late in 2021 as United Natural Foods, Inc. saw strong operational growth, and the market turned upbeat on this. Ever since, shares have sold-off, now trading at $30 per share, and the latest setback is substantial on the back of poor news.

Since the outset of the pandemic, United has seen solid growth . Full year sales for the year ending in July 2021 rose to $27.0 billion, as revenues rose to $28.9 billion for the year ending in July 2022. The company has seen solid growth on the operational front with EBITDA improving to $770 million in 2021 and to $829 million in 2022, marking steady growth. Adjusted earnings for 2022 were posted at $4.83 per share.

Moreover, the company guided for sales to rise by about 4% in 2023 to a midpoint of $30.1 billion, with EBITDA set to advance further to $865 million, resulting in adjusted earnings of around $5 per share. Net debt has come down to $2.1 billion in dollar terms as improved EBITDA has reduced leverage ratios to 2.6 times, quite promising. This was aided by strong earnings power, which was maintained as the company divested some smaller assets as well.

In December, the company posted a 7.5% increase in first quarter sales to $7.6 billion, aided by inflation, although the same inflationary trends made that EBITDA rose just 3.5% to $207 million, indicating some modest margin pressure, although leverage increased (due to seasonality). Nonetheless, the company maintained the full year guidance.

Inflationary pressures hurt the business in a more pronounced manner in the second quarter. Sales rose 5.4%, with the pace of growth decelerating despite continued inflation. Adjusted EBITDA fell nearly 18% as a result of lower inflation (pressuring inventory gains) with EBITDA reported at $181 million.

The company hiked the midpoint of the full year sales guidance by two hundred million to $30.3 billion. The adjusted EBITDA guidance was cut by $115 million to $750 million, with adjusted earnings guidance cut by around one and a half dollar to $3.50 per share. Given the degree of the earnings shortfall, I am not surprised to see United Natural Foods, Inc. shares down from $40 to the high-twenties, shedding some $700 million in value in the process.

What Now?

The truth is that the slower pace of United Natural Foods, Inc. growth is actually tied to inflation, but if we adjust for pricing (which is not being shared), volumes are likely flattish year-over-year, or might be even negative. The company actually announced that inflation is decelerating, which looks beneficial, but results in lower gross margin (due to lower or absence of inventory gains). These gains have actually been a major driver behind recent earnings, as subsiding inflationary pressures and more pressure from supermarkets and other clients hurt the position of distributors.

Fortunately, United Natural Foods, Inc. net debt is down quite a bit, as the balance sheet is not completely out of the woods given the pace of the deceleration in EBITDA, which jacks up leverage ratios here. Given the more modest valuation and reasonable shape of the balance sheet, I am cautiously optimistic, but the performance of United Natural Foods, Inc. has been too mixed for too long to actually have real conviction here.

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