This Stock Will Beat the Market, Naturally

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Here's some food for thought: The U.S. organic industry clocked in $31.5 billion in sales in 2011, representing 9.5% growth. The overwhelming majority of this ($29 billion) was food and beverage. Furthermore, organic food sales now represent 4.2% of all U.S. food sales, up from 4% in 2010. And I am going to take part in this trend by introducing United Natural Foods (NASDAQ: UNFI  ) to my Real-Money Portfolio.

Keep it simple
In line with my investing philosophy, there are four things I look for when considering any investment:

  1. I want management I can trust. They need to be in it to win it, and they need to be honest.
  2. I want something that is understandable and that I can enjoy following.
  3. I want a catalyst -- a short-term event or long-term trend that will help create value.
  4. I want a fair price. Enough said.

Management I can trust; in it to win it
I've been following United Natural foods now for a few months, and in doing so have gotten some perspective on CEO Steven Spinner and the value he brings to the table. While he has been CEO of United Natural Foods since 2008, he has a long work history in distribution and has an excellent track record thus far. Under his watch, revenue has grown 11.5% annualized and earnings at an even better 17% annualized.

And shareholders have won, too. The stock has returned almost 160% since Spinner took the reins, throttling the market in the process. The board is comprised of three committees: compensation; audit; and nominating and governance. There are nine members of the board with only one internal to the company in CEO Spinner, and the compensation committee is all external.

Understandable and interested
When you go to the grocery store, do you give any thought as to where the products you buy actually come from? Well, chances are very good that you are walking out with something that came from United Natural Foods' distribution network. With 26 distribution centers representing more than 6.2 million square feet of warehouse space, United Natural Foods is more than twice the size of its nearest competitor in a business where scale is a huge competitive advantage. And thanks to a supplier base of more than 4,800, UNFI isn't dependent on any one. In fact no supplier accounts for more than 10% of the company's total purchases, including its largest supplier, Hain Celestial (NASDAQ: HAIN  )

A long-term trend
There's no denying the growing trend toward organic and natural food offerings. One need look no further than Whole Foods Market's (NASDAQ: WFM  ) sales over the past decade, which have grown from about $2.5 billion in 2002 to more than $11.5 billion today, to see the writing on the wall.

Interestingly enough, Whole Foods is also UNFI's largest customer, representing approximately 36% net sales. Granted, that's heavy dependence on one customer, but the good news is twofold. First, UNFI has been Whole Foods' primary distributor for more than 14 years. And second, the two companies just renewed an agreement for UNFI to continue to be its primary supplier through September 2020.

And it's not just Whole Foods. UNFI is also a supplier to other popular chains such as Safeway, Publix, and Wegmans, to name just a few.

All at a fair price
Like I said before, scale matters in this business, and UNFI's wide-reaching distribution network gives it a competitive advantage over smaller players in the space. To be sure, the company is facing some near-term headwinds. Gross margin pressure due to shortages from suppliers that result in price-cutting, costs involved with the rollout of a national supply chain platform warehouse system, and plans to increase capacity via new warehouses are all threats to near-term profitability. But I do believe that management is working through the tougher times today to set this business up for long-term success.

If these investments in the business prove out over the long haul, I think that management should be able to sport an operating margin in the neighborhood of 3.5%, which makes me think that today's stock price is robust at around $53 per share. But remember, this is still a growth story and the company's standing as the top dog in the industry eases some of my concerns. I'm OK with paying for quality, especially if I think it's getting me in on a long-term growth story.

The Foolish bottom line
The landscape is changing for grocery shoppers. When I was a kid, Piggly Wiggly was the place to go (yes, I understand I've more or less dated myself here). But my kids are growing up on a new normal with organic and natural options. With the game still in the early innings, I see United Natural Foods as a great way to play the movement, so I'm adding $1,000 worth of shares to the Motley Portfolio.

Whole Foods Market has been a longtime pick of Motley Fool superinvestor David Gardner, and has soared more than 137% since he recommended it in February 2008. David specializes in identifying game-changing companies like this long before others are keen to their disruptive potential and helping like-minded investors profit while Wall Street catches up. Learn more about how he picks his winners with a free online tour of his flagship service: Supernova. Inside you’ll discover the science behind his market-trouncing returns. Just click here now for instant access.

Read/Post Comments (7) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 15, 2013, at 11:32 AM, joryko wrote:

    Great article, seems like a cheaper way to play the growth story at Whole Foods. UNFI's relationship with WFM is a huge growth runway in and of itself.

  • Report this Comment On January 15, 2013, at 3:01 PM, TMFJMo wrote:

    @jorkyo Thanks! I like their relationship with Whole Foods and I like the fact that they work with so many other names as well. Biggest player in the space by 2.5x in a market where scale is a huge deal.

  • Report this Comment On January 16, 2013, at 1:55 PM, joryko wrote:

    Indeed, a very promising company making smart acquisitions. 2.5x bigger and in a huge market that is still largely unsaturated, tremendous growth runway ahead.

  • Report this Comment On January 16, 2013, at 2:16 PM, rongreenberg7 wrote:

    not represented in this article is the heart and soul of unfi. before whole foods and the rolling out of natural foods in the mass market, unfi's primary retailers were independent natural food stores. they still comprise a huge portion of what unfi does. and unfi has been able to keep that loyalty and beat its competition even though they have been able to give mass marketers like whole foods better pricing. unfortunately for unfi, playing both sides of that street won't last forever and recently independent natural foods retailers have begun banding together, supporting unfi's competition, buying more product directly from smaller manufacturers and even beginning to private label their own brands. if whole foods should ever begin distributing its own products in house, and independents find other means of trucking food to their doors, unfi will be out of business or at least greatly diminished.

  • Report this Comment On January 16, 2013, at 2:55 PM, TMFJMo wrote:

    "if whole foods should ever begin distributing its own products in house, and independents find other means of trucking food to their doors,"

    Two big "if"s and I wouldn't be holding my breath for something like that. Beside the fact that their agreement was extended through 2020, UNFI also recently purchased assets from Whole Foods Distribution in the Rocky Mountain and Southwest regions in order to become the primary distributor in these regions as well. So they are now Whole Foods' primary supplier in every US region.

    I'm not saying it can't happen, but it appears that the two are building a mutually beneficial relationship in a market where scale essentially determines economics. And given the runway of growth left for Whole Foods stores alone, well you already know where I'm placing my bet.

  • Report this Comment On January 18, 2013, at 1:55 AM, djkumquat wrote:

    smaller manufacturers are not pleased with UNFI's service, and moving toward direct sales to mom n' pop natural foods stores and co-ops. on the flip side, WFM is enjoying the distribution relationship, and shows no real interest in dealing directly with manufacturers. as a result, the move to direct sales has been slowed by the desire of small manufacturers to get their products into WFM. as the relationship between smaller stores and manufacturers becomes more direct, UNFI could become more dependent on WFM. this trend could also push a larger supplier, such as HAIN, to over 10% of purchases for UNFI.

  • Report this Comment On January 18, 2013, at 2:02 AM, djkumquat wrote:

    PS - there's no denying the growth in organic product sales, so UNFI seems poised to continue its run in the short to mid-term (see contract with WFM to 2020). in the long run, perhaps being swallowed up by WFM would be good for investors?

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Related Tickers

9/26/2016 4:00 PM
UNFI $39.03 Down -0.09 -0.23%
United Natural Foo… CAPS Rating: ****
HAIN $34.63 Down -0.35 -1.00%
Hain Celestial CAPS Rating: ****
WFM $28.65 Up +0.13 +0.46%
Whole Foods Market CAPS Rating: ****