The explosion of the organic foods industry over the past few years is remarkable. Perhaps it is simply a reaction to the "I can feel myself getting fatter just being near a fast-food chain" lifestyle trumpeted by McDonald's
Luxury anything is selling. Folks aren't satisfied with a Cadillac -- now they want a BMW. It's not gold but platinum. Cruise the Bahamas? Oh, so cliched -- let's go to the Mediterranean. An old-school Bud Light? No, we want the frothy import that no one has ever heard of. And Folgers will never do -- give me the Banana Coconut Frappuccino Blended Coffee from Starbucks
And big business is cashing in. Ann Taylor's sales are trending up by recapturing that premium edge, Boston Beer
Following on the heels of United Natural's fourth-quarter results, we will dive into its latest conference call for clues as to what's in store for fiscal 2007 and beyond. In this latest edition of Fool On Call, we will highlight these areas:
- Improved distribution capability
- IT upgrades lead to cost savings
- The importance of Whole Foods
Getting products to customers, cheaper
CEO Michael Funk indicated in the call that in the fourth quarter fuel costs were up 21 basis points (as a percentage of operating expenses) from the year-ago period. To tackle the problem of rising fuel costs, United Natural Foods will look toward "aggressive" facility expansions, bringing distribution centers closer to customers.
To give you a sense of just how aggressive this will be, in fiscal year 2006 the company's capital expenditures were just over $19 million. Look for this figure to more than double in fiscal 2007, to a range of $40 to $45 million. These facilities, which are planned for completion within the next 18 to 24 months, will expand the company's presence in Texas, Florida, and the Pacific Northwest.
Obviously the costs of such an expansion are substantial, but the added business it will pick up in those regions -- in addition to the savings it will gain in reduced delivery costs -- will benefit the company over the long term. During the Q&A, Funk provided this example: The new distribution center planned for Florida will begin paying for itself right from the get-go simply by cutting down on delivery time -- any added business with the presence of the facility becomes a nice bonus.
Technology improvements lead to cost improvements
Sam Walton stated several times throughout his autobiography that he always looked for ways out of having to spend money on IT upgrades. In the end, he realized there was no way around it -- to keep a competitive edge, Wal-Mart must stay at the forefront of retailing and distribution technology. United Natural Foods has come to the same conclusion.
During the Q&A portion of the call, an analyst from Goldman Sachs noted that if stock options and rising fuel costs were factored out of the equation, United Natural Foods' expense control "kicked into another gear in the last two quarters." CEO Funk pointed to technology improvements as one contributing factor.
Over the next two quarters, look for IT upgrades in two of the company's facilities, with the installation of what Funk called Pick-To-Light and Pick-To-Voice systems. These upgrades are expected to immediately increase productivity, improve order-selecting accuracy, reduce training time, and eliminate wasteful paper and printing costs -- adding up to "significant operational savings."
The importance of Whole Foods
And no discussion on United Natural Foods is complete without some discussion of Whole Foods. Indeed, after an analysis of the conference call, it's impossible not to see the importance of Whole Foods to United Natural's business.
A couple brief observations: The new distribution facilities highlighted previously will be a particular benefit to United Natural's relationship with Whole Foods in the Texas market. Whole Foods does have its own distribution center in the area, but United Natural is already a strong secondary provider and is looking to increase its presence through the addition of this new facility.
Improving the company's delivery capability for Whole Foods becomes all the more critical when considering that the current contract between the two parties is set to expire at the end of fiscal 2007. By upgrading its distribution systems via facility additions and IT upgrades, United Natural is looking to increase its piece of the Whole Foods pie in the coming years. An analyst with Piper Jaffray noted that Whole Foods has a "huge pipeline of new stores" set for opening over the next 12 to 24 months. I guess it is no surprise, then, that United Natural has deemed it in the company's best interest to take a heavy capex charge in the upcoming year in order to aggressively expand its distribution capability.
Foolish final analysis
Retailers of all shapes and sizes are touting premium products. Whether it's HDTVs or cutting-edge cell phones or something as simple as organically grown berries, the flight to higher quality isn't going away any time soon. With Whole Foods growing like gangbusters, United Natural Foods is making strategic moves with facility additions and IT upgrades, putting itself in prime position to capitalize on this growth.
The relationship between these two parties is certainly one worth watching as the organic market continues to spread like wildfire.
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