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. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  6. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  7. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  8. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  9. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  10. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  1. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  2. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  3. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  4. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  5. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  6. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!