The results are in for FY20 for United Natural Foods (NYSE:UNFI), and the highlights are pretty amazing (from press release):

  • Reduced outstanding debt, net of cash, by $388 million; year-end adjusted EBITDA leverage ratio of 4.0x
  • Net sales increased to $26.5 billion
  • Adjusted EBITDA increased to $673 million
  • Adjusted EPS increased to $2.72

Despite beating earnings and revenue estimates, and raising FY21 guidance, the stock has sold off over 20%. Some are attributing this to the CEO’s retirement announcement, but given the nine-month timetable on that decision, the explanation leaves investors wanting more. No UNFI thesis on Seeking Alpha has referenced the management team as a company strength, and if anything, the mistakes and debt burden from the Supervalu acquisition are a reminder of the team’s missteps.

Possible other explanations:

  • Q4 cash generation fell short of investor expectations
  • Relatively significant number of shares (~2m) granted to management, diluting investors
  • Lack of CEO successor
  • Lack of Whole Foods contract extension
  • Margin pressure on FY21 revenue

While all of these could be part of the story, I still don’t see it. It is true that management expects Q3/Q4 21 to be tough comps Y/Y, but the fact it continues to guide above expectations for revenue and EBITDA after a blowout year shouldn’t be taken for granted. It has a good track record of setting reasonable guidance it can beat, which is even more encouraging.

Regarding the Whole Foods contract, the last extension was announced Nov 2nd, 2015. I expect a similar announcement in the coming couple quarters, removing a significant overhang from the stock.

Valuation

Updating the valuation waterfall, I’ve included company guidance for FY21, assuming cash balance and market cap at current levels, and showing debt paydown of $310 which reflects EBITDA midpoint of $710m, less $225m for CapEx and $175m for interest expense. (Guidance was for at least $300m of paydown):

FY20

FY21 Guide

Long Term Debt

2,735

2,425

Cash

47

47

Market Cap

900

900

EV

3,588

3,278

Adj EBITDA

673

710

EV/EBITDA

5.3

4.6

Debt/EBITDA

4.1

3.4

Adj Price/Earnings

5.0

4.1

(Source: Company Financials)

It’s worth noting the EV/EBITDA was 6.2x at the beginning of this year, and debt/EBITDA was 5.6x, again reflecting the massive reductions in leverage that have taken place over just a couple quarters. While I don’t like “Adjusted” earnings per share, it’s worth noting that FY21 adjusted and actual earnings are finally converging with non-cash write-offs and integration expenses finally falling away. UNFI will screen with a P/E around 5 that has been obscured until now.

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Deeper Dive Valuation

Even though UNFI just keeps getting cheaper by any valuation metric, the market hasn’t been convinced. So I want to take a different approach to highlight just how massively undervalued this business remains.

First, let’s talk Cubs and Shoppers. Management acknowledged on this conference call that it expects $200m of proceeds from selling the Cubs real estate as part of the eventual divestiture of that segment. In FY20, the retail segment did $2.3B of revenue, resulting in $86m of EBITDA.

  • Using Kroger (NYSE:KR) as a comp, that gets you to $460m (0.2x P/S) or $600m (7x EV/EBITDA).
  • For investors hesitant to use such a large chain, Weis Markets (NYSE:WMK) would comp to $690m (0.3x P/S) or $520m (6x EV/EBITDA).
  • Even smaller, Village Super Market (NASDAQ:VLGEA) has the same ratios as Kroger.
  • Ingles Markets (NASDAQ:IMKTA) would be the best downside comparison, with similar P/S and 5x EV/EBITDA.
  • Thus, I feel it is safe to value the ongoing businesses at $500m, and combined with the real estate at $700m, with upside to $800-900m possible.

Look at how the valuation of UNFI gets even better if you strip out my base case accordingly (including removing the $86m from FY20 and an estimated $100m from FY21 EBITDA for retail):

FY20

FY21 Guide

Long Term Debt

2,035

1,725

Cash

47

47

Market Cap

900

900

EV

2,888

2,578

Adj EBITDA

587

610

EV/EBITDA

4.9

4.2

Debt/EBITDA

3.5

2.8

(Source: Author Estimates)

If the $900m upside sale took place, the Debt/EBITDA at the end of FY20 would practically be at 3x already, and remember this is down from 5.6x one year ago!

Next, let’s turn to the other real estate. There is 1.1m square feet of owned real estate on the retail side, which as discussed management expects from this $200m of proceed. On top of this, there is 13.3m square feet of owned distribution centers, 3 million square feet of surplus owned retail space and distribution centers, and 295 thousand square feet of owned office space.

Valuing these sites is obviously a challenge, but a couple ways to think about them would be as follows:

  • Tacoma just sold for ~$40m, a 654k square foot facility. Applying this multiple to the other centers would imply ~$800m of value. Mixing the other ~3.3m of owned properties between the retail and warehouse value per square foot would imply $200-600m of value, which I will midpoint at $400m.
  • From a different angle, there are about $180m of lease payments due in FY21 for about 20m square feet of total leased real estate, implying ~$6/square foot/year. If UNFI sold back its other ~16.5m owned real estate at a 7% cap rate, that would result in 6/.07*16.5m = ~$1.4B value.
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I therefore find valuing the remaining owned real estate at $1.25B to be a fair estimate of value. Given we already showed debt could be $1.7B conservatively after the sale of Cubs, the remaining owned real estate could almost cover the remaining debt. I don’t see the value in a sale/leaseback here at 7% when it is paying an effective rate on its variable debt of 3.6%, but it could extinguish it almost in full if desired. The incremental payment of $6/square foot on that real estate would also impair EBITDA by about $100m per year.

Pulling It All Together

Between its debt, cash, and stock, the market currently gives UNFI an enterprise value of $3.7B, expected to drop to $3.4B by end of FY21, with the stock price being constant. Selling Cubs and the other owned real estate would produce about $2B of proceeds, while impairing EBITDA by $180m (TTM) and $200m for FY21 (EST), but would also mostly extinguish the current ~$175m of interest expense. I’ll show earnings of $100m (FY20) and $120m (FY21).

FY20

FY21 Guide

Sale-Adjusted EV

1,700

1,400

Sale-Adjusted EBITDA

493

510

EV/EBITDA

3.4

2.7

Adj Price/Earnings

9.0

7.5

(Source: Author’s Estimates)

Would you buy a business with numbers like this, with practically no debt, growing on top of a record year, counter-cyclical at the midst of a pandemic and contentious election, and the imminent catalyst of extending a contract that covers almost 20% of company revenues that irrationally spooks investors?

SpartanNash (NASDAQ:SPTN) is the best publicly-traded comp for UNFI as a whole, which trades around 7.5x EV/EBITDA or 6x Forward EV/EBITDA. UNFI would need to double to get to these multiples. Stripping out the owned real estate and Cubs would imply a $48 share price to approach SPTN’s forward multiple. Neither of these comparisons applies a premium to UNFI for being a larger distributor/industry leader.

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Other Observations From the 10-K

Total liquidity as of August 1, 2020 was $1.28 billion

  • I don’t think it has a liquidity problem.

In fiscal 2021, we are obligated to make a $72.0 million prepayment from Excess Cash Flow (as defined in the Term Loan Agreement) generated in fiscal 2020, which we satisfied with a $72.0 million payment in the first quarter of fiscal 2021.

  • Case and point, the company already met its debt payment obligations for FY21 at the time of filing.

We contributed $16.1 million and $2.6 million to our defined benefit pension and other postretirement benefit plans, respectively, in fiscal 2020. In fiscal 2021, no minimum pension contributions are required to be made under the Unified Grocers, Inc. Cash Balance Plan or the SUPERVALU Retirement Plan under Employee Retirement Income Security Act of 1974, as amended (“ERISA”)

  • Pension plan funding is not a major concern here; plans are in good shape.

We made contributions to these plans, and recognized continuing and discontinued operations expense, of $52.3 million, $41.3 million and $0.5 million in fiscal 2020, 2019 and 2018, respectively. In fiscal 2021, we expect to contribute approximately $45.2 million related to continuing operations contributions to the multiemployer pension plans, subject to the outcome of collective bargaining and capital market conditions.

  • Multiemployer pensions can be a bear, it’s very good to see it’s decreasing the contributions for FY21. Withdrawal liabilities also go down when contributions are lower over time.

We are primarily self-insured for workers’ compensation, general and automobile liability insurance.

  • Seems odd the company isn’t self-insured for medical benefits. This seems like an area of possible savings going forward. Often employers can save 5-10% per year when going self-insured at scale.

Conclusion

The market reaction to UNFI’s blowout earnings is baffling. Shares are undervalued to a tune of 2-3x peer SpartanNash using conservative valuation metrics and relying on guidance from management that has traditionally been conservative. UNFI offers the additional upside of acting as a hedge in a recessionary environment.

In the long run, the markets are a weighing machine, and UNFI’s tantalizing value will eventually be realized.

Disclosure: I am/we are long UNFI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



Via SeekingAlpha.com