Joel Tillinghast: A taste for organic food

United Natural Foods (Ticker: UNFI)

The rise of Big Organic

“Texas” and “organic” are not words that generally appear in the same sentence. But Wal-Mart is doing its bit to change that. At the company's 24-hour “super center” in Plano, a McMansionized suburb of Dallas, boxes of organic apples, bananas and kiwis nestle close to the entrance, and the meat department is stacked high with “all natural” chicken. You can find spinach-flavored organic baby food and dairy products supplied by Horizon Organic in Colorado.

Wal-Mart opened the Plano store in 2006, as a laboratory for new products. The several hundred organic and “natural” items are a highlight. On the non-organic side, it has a posh coffee shop offering raspberry-truffle lattes, a good wine selection and an excellent sushi bar. Wal-Mart, built on the idea that ordinary folk want good, honest value-for-money, is reaching out for the yuppie dollar.

The firm is hardly alone in embracing organic food. The age of “Big Organic” has dawned. Also in 2006, Supervalu, which owns Albertson's and other grocery stores, started a line of organic apple sauce, canned tomatoes and other delicacies. Safeway, another grocer, has an organic line and McDonald's has heavily promoted its coffee, which is now blended with beans from Newman's Own Organics.

Everyone, it seems, is envious of Whole Foods Market. Yet no one admits to being more surprised by the runaway success of Whole Foods than its boss. “In all my profound wisdom I decreed a maximum of 100 stores, and thought that would saturate the United States,” recalls John Mackey of the time when his company went public in 1992. That in itself was quite a milestone for a grocery retailer that he began in 1978 in a garage in Austin, Texas, when he was living in a vegetarian co-op. At first, hippies and college students were his main customers. But now, with about 270 stores feeding the organic-food-addicted middle class in the U.S., Canada and England, Whole Foods has become firmly established as the world's largest natural-foods chain.

To understand the allure of Whole Foods, look no further than its Austin, Texas, landmark store. Occupying almost 80,000 square feet, it is one of the firm's largest, and features a vast array of treats, from organic enchiladas to an in-house meat smoker. There are sampling stations, cooking demonstrations and café tables galore. Employees, called “team members”, are as enthusiastic as the shoppers, and gladly explain company policy on, say, sustainable fishing (no Chilean sea bass, for instance, as it is seriously over fished). The firm is starting to label its own-brand foods to indicate any genetically modified ingredients.

There are, however, supply problems. At some Whole Foods stores, up to 60% of the produce is organic in the summer – but that number dips in the winter because “natural” food has to respect the seasons. This is also a shortage of organic farms. Step forward $766.14 million (market cap) United Natural Foods (Ticker: UNFI), the largest nationwide distributor of natural, organic, and specialty foods. Whole Foods accounts for more than 30% of UNFI’s sales.

Born from a merger of two leading natural-foods distributors in 1996, UNFI is essentially a roll-up of natural and organic distributors. The company has built unrivaled economies of scale in the distribution of more than 40,000 natural and organic products. The firm is more than twice the size of its nearest competitor, Tree of Life.

As the largest distributor of natural and organic products, UNFI stands to benefit from consumers' increasing appetite for health and wellness products. It will also get a boost from stepped-up store expansion from Whole Foods and higher demand from conventional grocers. Another potential area of growth is expansion into specialty foods such as gourmet, ethnic, and kosher.

To be sure, UNFI has recently had a number of operational setbacks and underestimated the challenges of integrating its first significant acquisition in specialty foods, Millbrook. Even so, UNFI still represents a solid long-term growth story. Certainly Joel Tillinghast’s Fidelity Low-Priced Stock Fund thinks so, having added to its shareholding recently.

At $17.87, on a forward p/e of 12.58. UNFI looks attractive.