Lower P/E Ratios Could Undervalue Some Companies in the NBCIFood & Beverage and Retail & Distribution Segments

NEW YORK—Many publicly traded natural products companies have seen precipitous drops in their stock price since the market decline began in August. This has led to a large drop in the price to earnings ratios (P/E) for companies and entire industries, including natural products and dietary supplements companies.

Indeed, the industry’s average P/Es are at levels closer to those for some of the broad market averages. As of Nov. 25, 1998, the Food & Beverage and Retail & Distribution segments of the Natural Business Composite Index™ (NBCI) have P/E ratios that are down 51% and 34.6%, respectively, since Jan. 29, 1998. While the stocks of many of these companies rose in October and November, the P/Es of these companies are still significantly below the top levels of 1998.

The P/E ratio is considered a measure of investor confidence—the higher the ratio the more the company is expected to grow earnings per share. Through July, stocks across many industries were trading at P/E levels that were much above what had been seen historically. The average P/E of certain major stock indices were above 24 in comparison to long-term average P/Es of around 15.

The natural foods industry has exhibited more volatility than the broader market, a characteristic of immature, high-growth industries. Currently, natural products stocks are, for the most part, still trading at a premium to the overall market, although the premium has significantly narrowed.

The Food & Beverage and Retail & Distribution segments of the NBCI have average P/E ratios of about 21.6 and 22.9, respectively, compared to about 21 for one broad stock-market index. Earlier in the year the premiums were 44.1 and 35, respectively.

Until the last few years the industry’s November P/Es would have been considered high and still are relatively high in today’s market.

The decrease in the Food & Beverage segment average P/E ratio represents a drop of 51% through November. While most of the companies in the segment have seen significant decreases in P/E, a few companies stand out as being contrary to the trend. Celestial Seasonings (CTEA) and Worthington Foods (WFDS) are notable for having increased their P/E ratios over the period. These two companies are well established, have performed well through 1998 and did not have inflated P/E ratios in January. Also, the Food & Beverage segment has been outperforming the other segments of the NBCI all year in terms of sales growth and profitability.

The Retail & Distribution segment average P/E dropped 34.6% for the same period. This segment’s decrease is due to a variety of factors. First, General Nutrition Centers’ (GNCI) announcement regarding inflated inventories and significant price discounting sent the stock plummeting. Second, GNCI’s primary competitors, Whole Foods (WFMI) and Wild Oats (OATS) suffered as a result, although some analysts believe that these stocks, along with the entire sector, were due for a correction. Alternatively, the P/E of United Natural Foods (UNFI) had the smallest decline, 9.4% since the beginning of the year, because management has delivered on its earnings forecasts.

What does the future hold for these companies’ stock prices? Except for GNCI, the companies mentioned above are trading at growth-stock multiples. GNCI, the largest natural products retailer, may be undervalued if one believes its excess inventory problem is a short-term issue rather than a major change in the marketplace.

Sol Halpern is an analyst for and Chuck Slotkin is president of Nature’s Equity Inc., a New York-based investment banking and business development firm specializing in the natural products industry. For more information, call 212.580.1666 or e-mail NEIChuck@aol.com.