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Whole Foods Market, Inc. (WFM), United Natural Foods, Inc. (UNFI): This Hidden Gem Is Supplying a Huge Growth Industry

Regular readers probably know I am a big fan of organic food companies, and I regularly use Whole Foods Market, Inc. (NASDAQ:WFM) as a proxy for organic retailing. According to the Organic Trade Association industry survey for 2011, organic food sales grew about 13.4% annually from 2002 to 2010, while conventional food sales remained largely flat. That kind of growth is about in line with that of Whole Foods Market, Inc. (NASDAQ:WFM), which has been at the center of it all.

Whole Foods Market, Inc. (NASDAQ:WFM)

But beyond Whole Foods Market, Inc. (NASDAQ:WFM), there’s United Natural Foods, Inc. (NASDAQ:UNFI), the industry’s chief distributor of organic food products. In fact, a third of the company’s sales come from Whole Foods Market, Inc. (NASDAQ:WFM), so the two companies’ fates are tightly interwoven. United Natural Foods, Inc. (NASDAQ:UNFI) released third-quarter earnings Tuesday and raised its full-year guidance, and there was a bit of good news and a bit of bad news to go around.

First, the good news
Net sales were up 13%, with net income up 9%, and the company raised full-year sales guidance to a range of $6.03 billion to $6.06 billion, from an earlier range of $5.88 billion to $5.98 billion. At the high end, that would represent close to a 16% increase over 2012 sales.

That seems unrealistic. To reach that level of growth, United Natural Foods, Inc. (NASDAQ:UNFI) would have to grow sales by more than 20% in the fourth quarter, with higher sales than this current quarter, which is traditionally the strongest of the year. Even Whole Foods Market, Inc. (NASDAQ:WFM) is estimating just 11% growth for its full year.

Still, even a crushing fourth-quarter miss would give United Natural Foods, Inc. (NASDAQ:UNFI) some growth for the year. That’s more than can be said for the company’s conventional counterparts. Safeway Inc. (NYSE:SWY) is estimating essentially flat sales growth, and analysts estimate that SYSCO Corporation (NYSE:SYY), the world’s largest food distributor, will see an actual drop in sales this year.

Now the bad news
In the press release, United Natural Foods, Inc. (NASDAQ:UNFI)’s CEO mentioned that the team had focused on “driving further operational excellence through the execution of our initiatives to increase leverage of UNFI’s cost structure.” Management should be applauded for cutting operating expenses as a percentage of net sales by 76 basis points, but unfortunately, it wasn’t enough to offset an 83-basis-point decline in gross margin over last year.

Even after certain adjustments for one-time expenses, total profit margin fell by 7 basis points, which may sound insignificant, but when your profit margin is 1.81%, every little bit counts.

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