United Natural Foods Under Delivered...Did the Market Overreact? The United Natural Foods selloff makes sense for now, but at some point the stock will be viewed as an opportunity and could quickly regain favor.

On March 8th, health foods distributor United Natural Foods, Inc. (NYSE:UNFI) delivered a quarterly update that could be summed up in one word — stale.

While sales grew year-over-year and beat Wall Street, profits fell sharply and missed the consensus estimate by a country mile. Making matters worse, management lowered its fiscal 2023 profit outlook and withdrew fiscal 2024 guidance.

To say investors gave up on United Natural Foods is an understatement. The stock fell as much as 35% on Wednesday in 13-times its 90-day average volume. It finished the day at $29.47, almost 50% below its post-pandemic peak.

The report showed how much North America's largest wholesale health foods distributor is still struggling with supply chain disruption. Network inefficiencies and inventory buildup continue to crush the company's profit margins. And they are doing so at a time when inflation is causing consumers to reach for fewer better-for-you (but worse-for-the-wallet) foods.

Why Did United Natural Foods Stock Drop?

United Natural Foods announced that sales were up 5.4% to $7.8 billion in the 13 weeks ended January 28, 2023. This was more than the Street expected, mostly due to price hikes. New product categories and new customer additions also contributed to the growth but a decline in units sold weakened the result. Then came the dagger.

Fiscal second quarter adjusted earnings per share (EPS) plunged 43% to $0.78. With analysts expecting a 27% improvement from the prior year, the miss was alarming.

CEO Sandy Douglas attributed the sharp drop in profitability to a lack of "procurement gains" compared to a year ago. At best, this clever wordplay masqueraded an escalating cost structure as a tough comp. In layman's terms, input costs and inventory levels swelled — never a good combination. Like Americans shopping for an organic dinner entree, the market didn't buy it.

What Is the Outlook for United Natural Foods?

As a result of the ongoing supply chain and inflation challenges, management slashed its full-year profit forecast. It now expects adjusted EPS of $3.05 to $3.90. This is well below its previous outlook and a far wider range. It reflects how unsure the company is about the next several months.

The uncertain operating environment also prompted United Natural to take its fiscal 2024 financial targets off the table. This didn't sit well with investors. Whenever visibility into a company's future profitability gets murky, the risk of its equity investment rises. Shareholders can decide if the elevated risk is worth the anticipated return. Many decided it was not.

Is United Natural Foods Stock Oversold?

Whether the punishing selloff was justified or overkill is hard to say. Any way you slice it, a steep decline in profits when the market-expected growth is disappointing. Citing supply chain issues three years from the onset of the coronavirus outbreak is concerning. The fact that United Natural is struggling to secure products (especially when it owns several of its brands) and improve operating efficiency when other consumer staples companies have overcome these hurdles is troublesome.

To be fair, however, United Natural's struggles are largely macro-driven. Freight, labor and other costs are up significantly elsewhere in corporate America. And with inflation impacting consumer behavior more than other "premium' categories (luxury apparel, cosmetics, etc.), expensive health food brands are being nixed from many grocery store shopping lists.

Longer term, the secular health and wellness trends that benefit United Natural Foods appear here to stay. As affordability improves, retailers will go back to ordering more from United Natural to match a bigger consumer appetite. If supply chain pressures ease in conjunction, profits should improve dramatically.

From a technical analysis standpoint, United Natural is undoubtedly oversold. On the daily chart, the RSI is around 14. When it was this low in September 2022, the stock rallied about 50% in two months. On technical indicators alone, a "dead cat bounce' seems likely but won't be sustained.

United Natural also looks too cheap from a valuation perspective. Based on the updated guidance, the stock trades at 8.5x this year's earnings. Its five-year average P/E ratio is roughly 12x.

United Natural has some kinks to work through in both the supply and demand parts of its business model. Pending a recession, it could be at least another two quarters before signs of progress. For this reason, the stock could be dead money for the remainder of the year.

Bottom line: the selloff makes sense for now, but it will be viewed as an opportunity at some point. As profit margins look healthier, United Natural could quickly regain favor as an appetizing play on healthy eating habits.