Summary: United Natural Foods (UNFI) reported fiscal 4Q23 results that fell within updated guidance the company provided in June 2023. We note that while sales estimates moved higher during the year, adjusted EBITDA guidance began at USD 850m-USD 880m in September 2022 only to be reduced twice during the year, the last time on 7 June with guidance of USD 610m-USD 610m, before reporting USD 640m. The company’s stock price sank 27.4% after the earnings release as fiscal 2024 (FY24) guidance was significantly lower than expectations. For FY24 ending on 3 August 2024, UNFI expects sales growth of 2.1%-4.1%, that includes a 2% benefit from a 53rd week. UNFI also projects a 14%-30% year-over-year (YoY) drop in adjusted EBITDA that includes a 1.4% benefit from a 53rd week. While slowing inflation remains a large factor in the decline in profitability, rising shrinkage has also been a contributing factor.
While overall inflation has moderated, some food categories are still affected by high inflation while others are experiencing deflation. Due to these higher prices, consumers are buying more value-oriented items in smaller quantities and are heading to discount retailers to make food purchases. With razor thin operating and EBITDA margins, UNFI needs to constantly be vigilant of its cost structure which remains a struggle as operating costs remain structurally higher than in the past.
FY24 could be a transition year as the company focuses on upgrading technology and attacks the cost structure. Management also needs to build credibility with investors after continued downward guidance. One has to wonder if FY24 guidance is on the conservative side to avoid another miss.
UNFI’s Wholesale business is comprised of Chains (supermarkets), including Wegmans, Key Foods, Kroger, The Fresh Market, and Fresh Direct, which represented 42% of FY23 sales. Independent Retailers were the second largest segment representing 25% of sales, while Supernatural sales, Whole Foods Market, which is a subsidiary of Amazon.com, accounted for 21% of sales.
It is estimated that UNFI and its largest competitors hold approximately a 60% market share - SpartanNash (SPTN: NASDAQ), and private firms C&S Wholesale Grocers (Safeway, Winn-Dixie, and Target), Wakefern Foods (ShopRite), Associated Wholesale Grocers, and KeHE (Sprouts Farmers Market and Publix) – with smaller players holding a 40% share.
For our valuation scenario, at the midpoint of our estimated adjusted EBITDA range and EV/EBITDA multiples, we find that all debt is fully covered with a stock price of USD 10.41 versus a current stock price of USD 14.50.
Debt, Liquidity and Cash Flow
On 29 July, UNFI had total debt of USD 2.0bn, and net debt of USD 1.98bn. The current debt is the lowest level since the 2018 Supervalu acquisition when debt stood at USD 3.35bn. During 4Q23, total debt was reduced by USD 70m. The company’s B1/B+ term loan, with USD 670m outstanding, matures in October 2025, while its USD 500m unsecured notes (B2/CCC+) matures in October 2028. Total and net leverage, as calculated by Debtwire, was 3.1x, but based on NTME adjusted EBITDA of USD 506m, leverage will be bumping up against 4x by the end of FY24. We expect total debt to rise to USD 2.1bn at 3 August 2024 as the company’s ABL is drawn further to fund higher capex.
On 29 June 2023, UNFI had total liquidity of USD 1.5bn consisting of USD 37m in cash plus USD 1.48bn of unused capacity under its USD 2.6bn ABL facility. With FY24 looking to be a challenging year, UNFI’s initiatives require an increase in capex of almost 25% to USD 400m from USD 323m in FY23 and USD 251m in FY22. With this increase in capex, we estimate that UNFI will burn USD 21m of cash over the NTM period.
Net cash from operating activities fell USD 140m YoY to USD 222m with free cash flow (FCF) of USD 117m after USD 105m of capex. For 4Q22, net cash from operating activities was USD 362m with FCF of USD 269m after USD 93m of capex.
While we don’t expect the company to utilize it in FY24 since we believe the emphasis is on debt reduction and capex, we note that the Board of Directors authorized a USD 200m stock repurchase program that runs until 21 September 2026. During fiscal 4Q23, the company repurchased approximately 791,000 shares at an average price of USD 26.49 for a total cost of USD 21m. For FY23, UNFI repurchased approximately 1.9 million shares at a cost of USD 62m (average cost of USD 32.84 per share) leaving USD 138m remaining under the program.
Recent Events
On 1 October, UNFI’s President Christopher Testa was terminated as the company aligns and simplifies its organization structure, including the oversight of its services and wholesale platforms. The company’s CEO, Sandy Douglas, who has been CEO since August 2021, assumed the role of President. (Prior to joining UNFI, Mr. Douglas served as CEO of Staples (April 2018-June 2021), and the President of Coca-Cola North America. Mr. Douglas had a 30-year career at Coca-Cola.)
On 26 September 2023, UNFI announced the addition of three new members to its Board of Directors as part of the company’s customer and supplier focused transformation plan and commitment to strong corporate governance and shareholder value creation. The three new members, Lynn Blake, James Loree, and James C. Pappas, bring decades of experience in investment management business strategy, finance, digital innovation, and technological transformation. James C. Pappas’s firm, JCP Investment Management, entered into a Cooperation Agreement with UNFI, that included certain customary standstill (limit the accumulation of no more than 9.9% of stock; JCP currently owns less than 1%), voting, and other provisions, as well as the temporary increase in the size of the board. According to FactSet, JCP Investment management has approximately USD 209m of assets under management with Kirby Corp (KEX: NYSE), Jack in the Box (Jack: NASDAQ), Berkshire Hathaway (BRK.B: NYSE), and UNFI being its largest positions. JCP also holds a small position in US Foods Holdings (USFD: NYSE).
The board will also oversee a financial review designed to enhance the company’s performance and drive shareholder value creation with a focus on evaluating and optimizing the company’s financial position that will include prioritizing the best financial resources to support the company’s strategy that will strengthen the balance sheet. On its 4Q24 earnings call, the company was asked about the possibility of divesting its Retail business that primarily operates in the Minneapolis-St. Paul area. While management was noncommittal on selling this business, we note that the Retail segment represents less than 10% of net sales.
UNFI has pursued actions to enhance near-term profitability measures that should reduce costs by close to USD 150m in FY24. Some of these measures include lowering SG&A spending, reduce organizational complexity to increase efficiency, maximize operating efficiencies in distribution centers by better managing inventory (exit underperforming stock keeping units (SKUs)), and reviewing contracts for greater consistency. These initiatives do not include the potential opportunity from improving the company’s shrink rate.
In an effort to modernize and unify its technologies, infrastructure, and processes to drive better service to customers and suppliers, as well as improve the internal analytical capabilities, the company has embarked on a multi-year “One UNFI” plan that includes four pillars of transformation:
- Network automation & optimization is currently underway as the company is automating its distribution centers. In September 2022, the company announced an agreement to implement Symbiotic’s (NASDAQ: SYM) artificial intelligence-powered robotics and software automation in five of UNFI’s distribution centers over the next four years with an option to implement these systems in additional distribution centers. The company’s Centralia, Washington distribution center will be the first installation with additional distribution centers to follow.
- Commercial value creation involves standardizing customer contracts that has been occurring over time and could begin to show results.
- Digital offerings will expand data to drive increased volume with targeted recommendations.
- Technology infrastructure unification and modernization will continue reducing the disparate technology platforms from past acquisitions to just one.
In April, Moody’s changed the company’s outlook to negative from stable, and affirmed UNFI’s corporate family rating at Ba3, senior secured term loan at B1, and senior unsecured notes at B2. The rating agency stated that “the change to a negative outlook reflects UNFI's weaker than expected operating performance and credit metrics primarily due to lower than expected gross margins, as well as higher than expected operating costs resulting from supply chain disruptions. The negative outlook also captures the risk that earnings will take longer than expected to improve, which will could delay the recovery in credit metrics. The affirmation of the Ba3 rating reflects Moody's expectation that UNFI's formidable size in the supermarket distribution industry supports its ability to meaningfully improve operating costs over the next 12-18 months as inflation, elevated freight costs and supply chain disruptions ease.”
In June, Standard & Poor’s (S&P) lowered UNFI’s issuer credit rating to B from B+-, the rating on its term loan to B+ from BB-, and its unsecured ratings to CCC+ from B- noting that “UNFI’s profitability will remain pressured through fiscal 2024 amid a challenging macroeconomic backdrop…We view UNFI's EBITDA margins as below average for the industry. The company's S&P Global Ratings-adjusted EBITDA margins have hovered in the high-2% to low-3% area since the Supervalu Inc. acquisition in 2018. While the transaction increased scale and cross-selling opportunities, management in its third quarter earnings call reported that Supervalu's long history of mergers and acquisitions limited UNFI's ability to understand the recent volatility within its businesses real time. This was exacerbated by supply chain constraints from the pandemic that remain unresolved. We note persistent risks in the highly competitive wholesale food distribution sector and with UNFI's concentrated exposure to Whole Foods Market Inc., which makes up about 20% of total sales and has a contract through 2027.”
UNFI Outlook
The outlook for FY24, a 53-week year, reflects lower levels of anticipated procurement gains, driven by moderating levels of inflation to the low- to mid-single digits compared to over 9% in FY23, as well as the restoration of performance-based incentive cash compensation of approximately USD 62m. UNFI also expects volume headwinds as consumers continue to adapt to higher costs. The expected decline in adjusted EBITDA reflects USD 125m in lower procurement gains, primarily in fiscal 1Q24 and 2Q24.
Debtwire Estimates
Valuation
For our valuation scenario, we use a range of adjusted EBITDA from USD 456m-USD 556m and multiples of EV/adjusted EBITDA of 4.5x-6.5x. At the midpoint, we find that all debt is fully covered with a stock price of USD 10.41 versus a current stock price of USD 14.50. We note that competitor SpartanNash trades at a NTME adjusted EBITDA of 5.2x. At this multiple, UNFI’s common equity price would be USD 7.82.
UNFI’s 6.75% senior unsecured notes due 2028 look cheap when compared to US Foods’ 6.875% senior unsecured notes due 2028. Looking out over the next five years, UNFI’s notes yield over 500bps more than USFD’s notes with both firms having the same net leverage. In addition, UNFI’s TLB due 2025 yields 8.7% compared to USFD’s TLB due 2026 yielding 6.7%.
The Details
Net sales for fiscal 4Q23 increased 2% YoY to USD 7.4bn from USD 7.3bn for fiscal 4Q22, primarily driven by inflation and new business, the latter included selling new or expanded product categories to existing customers as well as adding new customers. The increases were partially offset by a decrease in total units sold. While unit volumes continued to decline, there was a 100 basis point sequential improvement from fiscal 3Q23. By segment, Wholesale increased 2.7% YoY as Chains, Independent Retailers, and Supernatural rose 0.5%, 1.3%, and 9.5%, respectively, while Retail and Other fell 1.9% and 3.7%, respectively. In the Retail segment, lower unit volumes were partially offset by higher average unit prices. For FY23, net sales rose 4.6% to USD 30.3bn.
UNFI’s 4Q23 gross profit fell 8.3% YoY to USD 966m from USD 1.05bn a year ago. Excluding the non-cash LIFO charge in both periods, gross profit decreased 9.6% YoY. The gross profit margin for 4Q23 was 13%, including the USD 36m LIFO charge, and 13.5% excluding the charge. This compared with 14.5% for 4Q22 that included a USD 56m LIFO charge, and 15.2% excluding the charge. The decrease in gross profit was primarily driven by lower procurement gains, reduced benefits from inflation, and higher levels of shrink. For FY23, gross profit fell 1.2% to USD 4.1bn and a 13.6% margin compared to USD 4.2bn (14.5% margin) for FY22.
Operating expenses in fiscal 4Q23 rose 2.4% to USD 1bn from USD 980m for 4Q22 with operating expenses for both periods representing 13.5% of net sales. The 4Q23 period benefited from lower transportation and distribution center labor costs due to a decrease in volume, and lower incentive compensation expense driven by underperformance compared to targets. These benefits were offset by investments in transformation initiatives, and higher occupancy-related costs.
Adjusted EBITDA for 4Q23 was USD 93m (1.3% margin) compared to USD 213m (2.9% margin) for 4Q2, primarily driven by lower gross margins due to reduced wholesale procurement gains. For FY23, adjusted EBITDA fell 22.7% to USD 640m (2.1% margin) from USD 829m (2.9% margin).
Business Description: United Natural Foods, Inc is a leading distributor of natural, organic, specialty, produce, and conventional grocery and non-food products, and provider of support services to over 30,000 unique customer locations in all 50 US states and all ten Canadian provinces. As of 29 July 2023, UNFI had 55 distribution centers and warehouses, as well as a manufacturing division and a branded product line division. UNFI has been the primary distributor to Whole Foods Market for more than 20 years and its amended distribution agreement runs through 27 September 2027. In FY23, Whole Foods Market was UNFI’s only customer that represented more than 10% of total net sales, accounting for 21%. The company’s Retail operations has 54 Cub Foods and 24 Shoppers Food Warehouse stores primarily located around Minneapolis, MN. The company also supplies another 26 Cub Food stores operated by its Wholesale customers through franchise and equity ownership arrangements. International net sales represented approximately 1% of total net sales. As of 29 July 2023, UNFI had approximately 29,455 full and part-time employees or which 36% are covered by 49 collective bargaining agreements that expire through 31 May 2027. In the past, the company has been the target of union-organizing efforts, and believes it is likely to happen again in the future.
