UNFI - United Natural Foods: Shocking Earnings Shortfall And Value Destruction

2023-06-30 17:28:26 ET

Summary

• United Natural Foods, Inc. sees a continued free fall in earnings.
• The degree of the earnings shortfall is shocking and might even spark some (renewed) leverage concerns again.
• The pandemic provided a lifeline, but the operational performance remains too lackluster to get upbeat about unless external involvement pressures management.

In March of this year, I concluded that shares of United Natural Foods, Inc. ( UNFI ) were not out of the woods. This came as United Foods made an expensive and leveraged deal for SuperValu pre-pandemic, nearly bankrupting the business, as the pandemic provided a lifeline to the business.

This pandemic and inflationary pressures pushed up both sales and margins, allowing for some deleveraging, yet with inflationary pressure subsiding I was shocked by the extent of the earnings shortfall in March, a trend which is continuing here.

Some Perspective

In the 2010s, United Natural Foods was a darling among investors, as the company played an active role as a consolidator in the market for the distribution of healthier and organic foods. The stock peaked at $80, and back in 2018, it was a $10 billion business which generated about $340 million in EBITDA.

This all changed as the company announced a $3 billion deal for SuperValu in the summer of that year, adding $15.6 billion in sales and $400 million in EBITDA. Note that these activities were not comparable, as SuperValu was a supermarket chain, resulting in larger depreciation charges.

The idea was to create a $25 billion revenue business with $700 million in EBITDA (and two hundred million more post synergies). Leverage was high, with net debt equal to $3.3 billion, although pro forma earnings of around $4 per share looked interesting.

Pre-pandemic, the company was lagging compared to these pro forma numbers as shares fell to the mid-single digits, but then shares rose in a spectacular fashion to the $50 mark in 2021. This was driven by the fact that sales for the year ending in July 2021 rose to $27.0 billion on which EBITDA was reported at $770 million, all the result of the pandemic of course. In fact, growth continued in the fiscal year 2022, with sales reported up to $28.9 billion and EBITDA improving to $829 million, equal to $4.83 per share.

In fact, the company guided for 2023 sales to surpass the $30 billion mark with EBITDA seen at $865 million, for earnings close to $5 per share. Moreover, net debt has come down to $2.1 billion, as the strong earnings power reduced leverage to 2.6 times.

Promise Does Not Come Through

After issuing a big guidance for 2023, it was clear that the business has been hurt by inflationary pressures which went on the reverse. While first quarter sales, as reported in December of last year, still rose by more than 7%, EBITDA was up a mere 3%. The problem showed up in February as the company posted a 5% increase in second quarter sales, although that EBITDA fell 18% due to inventory losses.

This made that the company hiked the sales guidance by two hundred million to $30.3 billion, whilst cutting the EBITDA guidance by $115 million to $750 million, with earnings now seen at $3.50 per share. This made that shares fall to the higher-twenties (falling overnight from $40) in March.

Amidst this background, I was glad to see some deleveraging, although the degree of the earnings shortfall was shocking, and in fact, pushed up leverage ratios again. For valuation reasons, I was becoming a bit more upbeat, but the mediocre performance has been going on too long to have a conviction on that thesis.

Moving Another Leg Lower

Since the spring, when United Natural Foods shares fell to the higher twenties, shares have now come down to the $20 mark, in fact, trading just below that. This came as third quarter results ( released in June) showed similar challenges. Third quarter sales rose by more than 3% to $7.5 billion, but adjusted EBITDA was down 19% to $159 million, resulting in adjusted earnings per share being cut in half to $0.54 per share. Moreover, note that the adjusted earnings metric does exclude LIFO charges, with GAAP earnings only coming in at twelve cents. The company managed to generate some cash flow, reducing net debt to $2.0 billion.

This is badly needed, as the company cut the full year outlook again. While the sales guidance was kept intact, the EBITDA guidance was cut further to $630 million with earnings per share now seen at $2.05 per share (at the midpoint of the range being down by about one and a half dollar per share) and GAAP earnings being largely non-existing. Moreover, the guidance implies that quarterly EBITDA will fall below the $100 million mark in the fourth quarter, probably the reason why the company announced the elimination of 150 jobs in the week following the earnings release.

With 60 million shares now trading at $20, the market value has shrunk to $1.2 billion. Ironically, if we add the net debt load of $2.0 billion we see an enterprise valuation of $3.2 billion, which incidentally matches the purchase price of SuperValu about five years ago. This tells you everything you need to know about the degree of value destruction since that deal was announced.

What Now?

The reality is that the degree of the earnings shortfall is shocking and concerning, as it even means that leverage issues might come into play as well.

While some job cuts are welcomed to halt the declines on the bottom line, the reality is that more structural issues need to be addressed, including the SuperValu deal, with or without the help of some external involvement or pressure.

Right now there is little fundamental support, but shares feel cheap here. Hence, quite some bad news appears to be priced in, although there are a few reasons to become upbeat here, even as this might be the time to get involved.

At maximum, I would be willing to hold a small speculative position in United Natural Foods, Inc. This is not necessarily in the hope of an organic turnaround story, but perhaps some external involvement would be welcomed here, with the fundamental performance being very soft, making me cautious to buy the dip.

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