While there have certainly been some pullbacks along the way, including a nearly 10% decline after fourth quarter earnings, United Natural Foods (Nasdaq:UNFI) has, by and large, basked in the love of growth stock investors. And not without some good reasons - United Natural has delivered excellent growth and market share gains, and has recently shown some solid margin improvements. I still think a key fundamental question remains, however, and that is whether investors are properly discounting what the company needs to spend on capex to maintain its growth rate into the near future.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

A Solid End to the Fiscal Year
I don't think investors were (or should have been) disappointed in the earnings that United Natural posted for the final quarter of its fiscal year. Revenue rose 16% as reported, or about 13% if the Safeway (NYSE:SWY) business is excluded. Either way, organic growth seems to be accelerating while inflation is moderating. Sales to major client Whole Foods (Nasdaq:WFM) increased more than 17%, while sales to supermarkets rose more than 24%. Sales to independents were less impressive, growing in excess of 9%.

Margins can wobble from quarter to quarter, but I'd say that the company's fundamental profitability continues to improve. Gross margin did pull back more than a point from last year and about 40 basis points from the third quarter. Operating income, on the other hand, rose more than 20% on a slight year-on-year margin improvement as the company's efficiency efforts seem to be paying off.

New Business ... Not Quite the Same As the Old
One of the longer-term concerns I have about this company is whether or not much of its growth is coming from lower-margin customers. Getting a bigger piece of the growing organic food distribution business is all well and good, but if the incremental margins don't look as good investors, ought to value that growth differently.

I don't believe that's behind the company's disappointing guidance, though. Management pointed to somewhat higher revenue in fiscal 2013 than the Street had expected, but the earnings guidance ($2.14 to $2.24) was lower than the prior average of $2.25. Here is one of the challenges of the UNFI model - although the company has been making progress on cost efficiency, it's not a straight-line path. In this case, the company is going to be consolidating some Colorado facilities and absorbing those costs accounts for much of the "miss" in guidance.

Can the Company Ever Post Impressive Free Cash Flow?
Another long-term challenge for the company is the inherent thin margins and free cash flow that goes with a distribution business. Given that the company seems to be pretty close to capacity, it seems probable that United Natural will need to build new distribution facilities over the next few years, and that's going to compress cash flow.

In the short term, this could actually be good for profit margins - the company may well have to turn away business if and when it's capacity-constrained, and I would expect that it would be the lowest-margin business that goes away first. Nevertheless, companies like Sysco (NYSE:SYY) and Nash Finch (Nasdaq:NAFC) have amply demonstrated that food wholesaling/distribution is just not a business that leads to wide free cash flow margins. This doesn't mean that this is a bad business or that the returns on capital and assets cannot be good; it does suggest, however, that investors need to be a little more aware of the sort of multiples they're paying for that growth.

The Bottom Line
United Natural Foods isn't at a point in its corporate lifecycle where investors care all that much about the free cash flow. Instead, they care more about the fact that this is a company with double-digit revenue growth, 20%+ EBITDA growth and growing share in an expanding industry. And to be fair, paying about 15 times EBTIDA when that EBTIDA is growing at 20% (similar to the PEG ratio) isn't such a bad thing for a growth stock. Discounted cash flow analysis isn't going to get you into this stock while it's still in its growth spurt. On the other hand, the company is likely looking at at least a few more years of double-digit EBTIDA growth. While I'd personally prefer to own this name at a low teens EV/EBITDA multiple (to cover some of the risk of EBITDA growth deceleration), I wouldn't be surprised if the stock continues to outperform on the basis of its strong growth in a generally low-growth industry.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  7. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  8. Stock Analysis

    The Biggest Risks of Investing in Qualcomm Stock (QCOM, BRCM)

    Understand the long-term fundamental risks related to investing in Qualcomm stock, and how financial ratios also play into the investment consideration.
  9. Stock Analysis

    The Biggest Risks of Investing in Johnson & Johnson Stock (JNJ)

    Learn the largest risks to investing in Johnson & Johnson through fundamental analysis and other potential risks. Also discover how JNJ compares to its peers.
  10. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
RELATED FAQS
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center