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Robust Demand for Natural Foods Continues as High-End Consumers Recover - Andrew P. Wolf - BB&T Capital Markets

67 WALL STREET, New York - March 23, 2012 - The Wall Street Transcript has just published its Restaurants, Food and Drinks Report offering a timely review of the sector to serious investors and industry executives. This Restaurants, Food and Drinks Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Shift Toward Healthier Food Options - Consumer Spending Patterns Polarize - Emerging Market Expansion - Baby Boomers, Millennials and U.S. Hispanic Preferences

Companies include: Attitude Drinks (ATTD); BJ's (BJRI); Coca-Cola Enterprises (CCE) and many more.

In the following brief excerpt from the Restaurants, Food and Drinks Report, interviewees discuss the outlook for the sector and for investors.

Andrew P. Wolf is a Managing Director and Senior Equity Research Analyst in the consumer group at BB&T Capital Markets. He has followed the food and drug merchandising sector for BB&T since 1999. In its World's Top Analysts survey in 2010, Financial Times/StarMine named him number two in the food and staples retailing for his stockpicking and earnings estimates; he also was named number one in 2009 for earnings estimates. Forbes.com ranked Mr. Wolf number five in 2009 and number two in 2008 in the food and drug retailers, wholesalers industry, in its Blue Chip Analyst awards. He also was cited in The Wall Street Journal's annual Best on the Street analyst survey for his stock picks in food and drug retailing in 2009, as well as in 2003 and 2004. Mr. Wolf also ranked in the top three for stockpicking from 2001 to 2004 and for earnings estimating from 2001 to 2003 and 2006 by Financial Times/StarMine in its annual Analyst Awards survey.

TWST: Do you have an overriding outlook for all those companies right now, or does it differ depending on the company and segment?

Mr. Wolf: It's bifurcated. Like a lot of the economic and sector analysis, it's definitely bifurcated along the economic lines of the have-more and the have-less, if you will. I wouldn't say it's the 99% and 1%, it's more like the 75% and 25%. For the 75% - which make up the large mass market, who shop at grocers, and frequent typical restaurants, the mid-market - that's where there is still a lot of price pressure. Those sectors lack pricing power, so gross margins are generally not expanding and in many cases contracting. That includes traditional supermarkets and food service distributors to most restaurants. Drug stores are doing a little better, because they're more defensive. Demand has been better there and new generic drug introductions are now boosting margins. Now, if you go to the natural foods vertical, where the four stocks I cover - Hain, UNFI, Whole Foods, and in functional foods Smart Balance (SMBL) - that sector of food consumption is really skewed toward the top 25% income earners. There is a lot of documentation by economists and marketing firms and others showing that that segment of the income-earning demographic has been in a recovery mode for over a year in terms of confidence, attitude, and ultimately, spending. So there has been a robust recovery for a number of reasons in that natural food vertical, and that's reflected in the valuations. Given this macro backdrop, fundamentals have been really very robust for these natural food merchants, and fairly tepid for the supermarkets and the food service distributors. That's talking about sales and earnings, typical fundamentals. The valuations reflect that. If you look at trailing EBITDA multiples, supermarkets are at about five times, drug stores are higher than that at about 7.5 times, and food service distributors are at eight times, while natural food merchandisers are at 15 times. These multiples are based on our BB&T group and subgroup indexes. So you see a have and have-not, in terms of reality and perception. I am not arguing that these multiples are grossly misvalued.

TWST: Let's talk about some specific stocks. What are your top picks right now?

Mr. Wolf: A lot of these natural food stocks have really worked, and they've gone up so much that the valuations, as I mentioned, are pretty full. That said, both Hain Celestial and United Natural, we have price targets that have some appreciation left. We would rather buy these stocks if the market weakens and things like that. But we think the stocks are heading up from here. Whole Foods, we have a "hold" on. It's really about valuation. It has a decent premium to the other two I just mentioned. We think that fundamentals for all three of those natural merchandising leaders are pretty similar, so it's just a relative value differential. But Whole Foods is doing great, too, and if that stock were to come in, we would probably look at how we are looking at it. We cover a business called Chefs' Warehouse (CHEF), which was a recent IPO. It is a small-cap stock with a little over $400 million market cap. It is based in New York City, but with an increasingly national presence, including on the West Coast. They sell into the higher-end restaurants. But similar to what I talked about the 25%/75% in food retail - where the natural food guys have that 25% upper income, folks who feel fine and have for awhile - Chefs' Warehouse is selling into the high-end restaurants, where the same consumer goes. The high-end restaurant has had a strong recovery. You see that in some of the public chains like Ruth's (RUTH) Chris and so on, where comps and same-store sales have been good after two horrendous years. Chef's Warehouse sells to the high-end restaurant sector, they sell to the independents. The demand has been very strong to higher-end restaurants, because the high-end demographic is in recovery. Beyond that, we think the company has a long runway to grow organically, internally, and through acquisition. They just did an acquisition in Portland, Ore. They've grown on the West Coast; they are in L.A. and San Francisco through acquisition. But there are a lot of major markets they should be able to get into, including Chicago, Boston, Texas, a lot of the food markets where they are not, and likely through an acquisition. And, I really like the management. Strong management. It's kind of like the natural foods industry. What's interesting about these companies - Whole Foods is still run by its founders; United Natural Foods, the Chairman of the board, Michael Funk, is still around; Irwin Simon at Hain. A lot of these people were there at the beginning of the natural foods industry, so their connections are so deep that the barriers to entry, relationship wise, are very strong. The same thing is going on with Chefs' Warehouse. The whole high-end food and celebrity chefs trend of the last 20 years - they were there for the beginning of that. They've been at this for a long time. And just like these natural food guys started with very small businesses - Walter Robb, the Co-CEO of Whole Foods had a store, I think, in Mill Valley that Whole Foods bought; Michael Funk, the Founder of United Natural Foods, was hauling odds and ends around Sacramento area, he switched to selling a lot of organic food - the same with Chefs' Warehouse. Two brothers founded this. Their dad was selling dairy stuff to the Greek restaurants in Queens, and one of the brothers went overseas to Europe and said, "Hey, there's this whole thing going on in Europe with high-end food." They built Chefs' Warehouse and started importing items from all over Europe, and now they are the biggest importer of fancy foods, a lot of it is domestic, too, but they are the biggest player in the fancy food market to restaurants. Beyond merchandising, a lot of what drives all my companies, particularly distributors, is their systems. They integrate their systems so that they can be incredibly efficient, because it's such a relatively skinny gross margin business. They have arguably way better systems than most small companies, which gives them a really strong platform as they go on. I think they can roll up the industry. That's going to be a really nice growing company for the next five, 10 years. I really like that business. And then our contrarian pick is Walgreen (WAG).

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