Natural Foods Shares Overvalued

Shares of organic and natural foods wholesaler United Natural Foods (Nasdaq:UNFI) tumbled more than 7% following the release of quarterly results that, while better than expected, failed to include a sales forecast for 2010. That little omission turned out to be a costly one as it did much to raise further concerns about the state of the organic foods marketplace.

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After years of double-digit growth, organic food sales have decelerated dramatically during the recent recession as even those with the income to spend on organic food have been forced to trade down, seeking out their recyclable bottles of pomegranate mango juice at such mass market retailers like Walmart (NYSE:WMT) instead of pricier outlets like Whole Foods (Nasdaq:WFMI).

Study Reveals Organic Foods Nutritionally Equal To Conventional Foods
Recent data reveals that the steep one-and-half year decline in organic food sales is showing signs of leveling out as core organic consumers appear to be sticking with the natural food mantra. However, real growth continues to depend on expanding the appeal of such products beyond that committed base.

And while price continues to remain a key hurdle, especially in these tough times, the question of just how much better organic food really is took a big hit recently when a major British review of more than 50 years of studies concluded that organic and conventional foods have the same nutritional content, implying that neither is healthier.

Sector Valuations Now Pricey
If much slower rates of long-term growth are the new normal for this specialty food sector, then sharp one-day sell offs like that experienced by United Natural, which followed hard on the heels of a similar sell-off last month by another purveyor of natural products, Hain Celestial (Nasdaq:HAIN), could be signaling that valuations for this group are a tad on the rich side at this juncture.

A clear example is Whole Foods, which now sports an expected P/E of 27x based on forecast earnings for 2009. United Natural appears less pricey given that its P/E based on next year's earnings is only 16x, but it could rise as 2010 earnings wilt. At least that's one takeaway from the company's reluctance to provide sales visibility going forward.

The Bottom Line
To expand beyond their core market, the organic and natural food purveyors will have to eventually lower their prices. If that happens, sales will have a chance of regaining their upward momentum, but at half the rate seen in recent years. Margins, naturally, will be lower. Under such a scenario, current multiples and prices look too high. (For more, see Top 10 Green Industries.)

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