Fresh Market Earnings: Decent Company, Not-So-Great Stock

Source: The Fresh Market. 

Upscale grocer Fresh Market (NASDAQ: TFM  ) came out with earnings this week, and the verdict -- both from myself and Wall Street -- is pretty clear: This a decent company that's significantly overvalued.

Before earnings came out, I identified three metrics that investors should keep their eyes on. Those metrics are listed below, as well as benchmarks that I thought would show healthy growth that matched the company's stock price.

 Metric

Benchmark

Actual

Met Expectations?

Profit margins

4.30%

4.41%

Yes

Sales per square Foot

$133

$122

No

Comparable-store sales

5%

3.4%

No

Source: SEC filings.

In my opinion, these mixed signals lead me to two key conclusions: The stock is overpriced, and the company's core message and offerings aren't resonating with customers.

Pricey stock
It's tough to get an apples-to-apples comparison for Fresh Market. The company operates in 25 states and has 139 stores total. Though it has a much smaller store-format size, and slightly different offerings, Whole Foods (NASDAQ: WFM  ) essentially goes after the same customers as Fresh Market. Recently IPO'd Sprouts Farmers Market (NASDAQ: SFM  ) could also be thrown into the same grouping.

When we look at Whole Foods, we see a company with a much larger presence -- more than 350 locations -- and a more mature store base. Despite this, the company has been able to achieve same-store sales increases of between 6.9% and 8.9% for the past six quarters -- much higher than Fresh Market's -- with superior profit margins to boot.

Whole Foods trades for 36 times earnings. Even after a 10% drop post-earnings, Fresh Market still trades for 34 times earnings. In other words, investors pretty much think Fresh Market's prospects are as good as Whole Foods' moving forward. Given recent results, that makes no sense.

If you want to get a look at a small grocer that's growing in a way that might warrant such a valuation, Sprouts offers an interesting case study. Operating primarily in the American Southwest, the grocer released earnings this month showing same-store sales had increased an incredible 10.8%!

What's at the core of this company?
I've already written before about how Fresh Market seems to be lacking a purposeful core. The stores are certainly nice, but traffic seems to be slow. When I visit the nearby location, I get the feeling that -- since focusing on expansion -- Fresh Market is nothing but a knock-off of Whole Foods, but without the impassioned focus on healthy eating, education, and sustainable/ethical sourcing.

If we dig a little further, we might see that other shoppers -- many of the same demographic that would frequent Whole Foods -- feel the same way. Of the company's 3.4% increase in same-store sales, only half of it -- or 1.8% total -- came from increased traffic. That's not great for a chain with a relatively young fleet of stores. Sprouts, for comparison's sake, increased traffic by 5.4%, while Whole Foods didn't break out this metric in its most recent report.

On the conference call, analysts were also quick to question why new Fresh Market stores were only showing a 79% productivity rate. New store productivity is a measure of how productive a new store's revenue is compared with established stores. Fresh Market executives aim for a range with a midpoint of 85%.

Taken as a whole, the message is clear: The Fresh Market isn't a "bad" company, but it's not an inspiring one, either. And in the grocery business, if you aren't inspiring, you certainly don't deserve such a high premium.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 30, 2013, at 11:30 AM, DavidTheJust wrote:

    Thank you for the article, but I beg to differ with you about SFM. The pop in SFM on its IPO reflects hope more than financial analysis. TFM is the better stock.

    Sprouts has a price to sales ratio that is nearly twice that of TFM even though TFM has much better financial characteristics in terms of margins, return on equity, and return on invested capital. It may be a rational choice for investors to avoid both companies, but it is difficult to see how long term investors are going to do better by purchasing SFM instead of TFM.

    The reason to consider TFM is simple: This is a fabulous business. Regretfully, many people buy stocks as though the underlying business doesn't matter. They get excited when earnings estimates pop up a couple of pennies a share or compare stocks simply on the basis of which company has faster sales growth.

    So what makes TFM such a great business? It's high margins and smaller stores allow it to earn back the cost of opening new stores very quickly. This means that it can fund virtually all of its growth from cash flow and borrowing rather than issuing new stock.

    A company that has a long runway of growing sales at 17-20% per year, when it is able to achieve such stellar returns on its invested capital can make its owners a lot of money.

    Is it a concern that new store openings aren't doing as well as existing stores? Of course. But this is also a normal hiccup (or growing pain) that would be expected in any small company. TFM is not cannibalizing its own sales and there is no reason to think that they will not be able to improve this metric in the future. The alternative is to believe that their existing stores just happen to be in the best possible locations in the country.

    Best wishes,

    David

    long TFM

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11/26/2014 3:59 PM
TFM $40.49 Down -0.36 -0.88%
The Fresh Market CAPS Rating: **
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Whole Foods Market CAPS Rating: ****

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