Tickers in this Article: UNFI, WFMI, COST, WMT, TFM, SYY, KR
There is nothing new about the organic food industry anymore, and investors are already well-attuned to the big names like Whole Foods (Nasdaq:WFM) and leading distributor United Natural Foods (Nasdaq:UNFI). The question, though, is whether there is still enough runway in front of UNFI to make the stock a worthwhile addition or holding for growth-oriented portfolios. While it is true that many major supermarkets like Kroger (NYSE:KR) and warehouses like Costco (Nasdaq:COST) could go even further in stocking more organic products, much of this seems to already be factored into UNFI's stock price.

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A Good Third Quarter, But With a Few Spots
For the most part, United Natural Foods had a solid fiscal third quarter. Reported revenue rose more than 22%, while revenue rose more than 12% on a like-for-like basis. While better than 10% growth from major customer Whole Foods was a bit below average, UNFI did see nearly 20% like-for-like sales growth in the conventional supermarket category. (For more insight, see Organic Food For Thought.)

Unfortunately, that supermarket growth comes at a bit of a cost, because it is not as profitable as UNFI's more traditional channels (smaller organic-focused chains with much less bargaining power). Gross margin slipped about 30 basis points as a result. UNFI made some of this up through operations, though, and 15% operating income growth mitigated the operating margin erosion to about 20 basis points.

Better Margins? They Have a Plan ...
United Natural is far and away the largest organic food distributor, but is only about one-10th the size of Sysco (NYSE:SYY). In a business where size, scale and profitability are intertwined, that's not a trivial detail and UNFI needs to work on improving its efficiency if shareholders are going to see a reward for owning these shares.

To that end, management does have some solid plans for better performance. The company is going to start better tracking of warehouse employees and using new management software. With better tracking, the company can not only identify its best employees and reward them accordingly (as well as retraining or firing the laggards), but also implement new standards and practices. All in all, there could be as much as 20% improvement just from picking this "low-hanging" fruit - and that's not trivial in such a low-margin business.

New Opportunities Balanced by Bigger Players
Supermarkets still have varying degrees of commitment to organic food offerings - even particular stores at chains like Ruddick's (NYSE:RDK) Harris Teeter, Alex Lee's Lowes Foods, or Supervalu (NYSE:SVU) can show a lot of variability in the stock and selection. Moreover, the organic selection at warehouses like Costco, Wal-Mart's (NYSE:WMT) Sam's Club, and BJ's (NYSE:BJ) is pretty paltry. Beyond that, too, are emerging specialty chains like The Fresh Market (Nasdaq:TFM).

So, the demand picture for organic food is looking good. The thing is, though, that working with these companies is a mixed blessing. Whole Foods is about one-third of UNFI's business and that is a powerful bit of leverage for Whole Foods if or when they need (or simply want) to use it. In a business where scale means everything, the loss of a major client like Whole Foods would be extremely painful. That means that UNFI has to balance the benefits of growth in channels like Wal-Mart and major supermarkets with the lower margins and stronger bargaining positions of those customers. (For more, see Winning The Organic Food Game.)

The Bottom Line - Much Is Already Assumed
United Natural looks like a fine story, but the stock already seems to reflect this. In fact, the stock price today seems to already be counting on a decade of 20%+ growth and the company achieving a level of free cash flow efficiency on par with Sysco in less than a decade. Maybe that is a goal the company can reach, but it's a demanding standard and one that does not seem to leave a lot of excess reward in the stock today. (For more, see United Natural Foods A Unique Grocery Store Play.)

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