The Great Organic Food Myth

Any fairy tale that involves monsters stems from society's fear of something. Fear is a visceral, primal human emotion. It causes people to do some really wacky things, like grab pitchforks and torches and storm the castle on the hill. When fear becomes institutionalized, it can mean huge profits for those who know how to take advantage of it.

So it is with the organic food movement, or so I hypothesize. Riding the cancer-fear wave, organic food manufacturers package their products and mythologize their brand. It's "organic," it's "natural," it's "healthy" -- the subtext being, "it won't cause cancer, and it's healthier for you."

But how much better is organic food for the body? And how much worse is regular food? Most people don't have the knowledge or data necessary to evaluate the risks, so they believe what they hear, even though there is a real lack of evidence determining whether organics are better or not.

Scientists in England just surveyed 162 articles of scientific literature over the past 50 years, and they found, according to Reuters, "no evidence that organic and conventional foods differ significantly in their nutrient content." Furthermore, the research in this area was extremely limited, with just 12 articles that directly addressed the health effects of organics.

Add to this the American Cancer Society, which says, "no research exists to demonstrate whether [organic] foods are more effective in reducing cancer risk than are similar foods produced by other farming methods."

Then again, these results won't derail the organic food industry. Once behavior becomes habitual, it is extremely difficult to change. Emotion overrides logic, and even though the data is inconclusive on this issue, you can bet that sales at organic purveyor Whole Food Markets (Nasdaq: WFMI) are not likely to be affected.

Good news for investors
After struggling the past three years, Whole Foods is expected to grow earnings an astonishing 60% this year, with an 18% growth rate over the next five years.

There are other plays in the sector, but not very many of them, and nothing like the pure play that Whole Foods is. Frankly, it's the ripest melon in the patch. Here's a financial comparison, but note that they each operate in a different sector of the organic world.

Source: Capital IQ, TTM = trailing 12 months.

As retailers of both organic and conventional foodstuffs, Kroger and Safeway provide diversification. Although stable companies, they don't interest me because they are struggling with earnings and are vastly overpriced as a result (on a PEG basis).

Distribution plays are always interesting, no matter the industry. Dean Foods is solidly profitable, the cheapest on a PEG basis. It has $4 billion in debt, against a market cap of under $2 billion. Interest expense runs to around 90% of free cash flow, so this is a company that could be hurt if it has to refinance at higher rates.  

United Natural Foods intrigues as a pure-play organic distributor. It's paying down debt, it recently started growing free cash flow, and analysts project a strong five-year earnings growth rate of 16%. It's a bit pricey for me at the moment, but I'm keeping on eye on it.

Hansen Natural is maker of natural and regular beverages, and Fool Anders Bylund thinks it may be a buy. I know it's an amazing growth story, and those plays deserve a premium value, but a 1.9 PEG is just too high for me.

In the end, I think Whole Foods is just right. The stock is expensive at 30 times this year's earnings, but Whole Foods simply isn't going to go away, its financials are solid, and it's the premier name in the sector. All those reasons might be enough to convince some investors to pay the premium.

Seems to me that no matter how you slice the whole-wheat bread, organic is here to stay, and after surveying the salad bar of investments, Whole Foods seems like the one stock to take to the cash register.