Why You Shouldn’t Be Buying The Fresh Market

Organic-food retail is a growing industry. That's why retailers and supermarket behemoths like Wal-Mart, Kroger (NYSE: KR  ) , and Safeway have started allocating space to organic- and natural-food products in order to drive more traffic to stores. The organic-food market in the U.S. is expected to grow to $80 billion by 2015, according to FarmExchange, and it is no surprise why these retailers and grocers are looking to make the most of it.

As bigger players move in, pricing pressure on pure-play organic- and natural- food retailers like The Fresh Market (NASDAQ: TFM  ) and Whole Foods Market (NASDAQ: WFM  ) is increasing.

Under pressure
The Fresh Market is the smaller of the two pure-play organic- and natural-food retailers. It is facing competition from a large and ambitious pure-play organic-food retailer -- Whole Foods Market -- apart from pricing pressures. These two factors seem to be taking their toll on the company's performance.

The Fresh Market posted lackluster third-quarter results, missing consensus estimates on both earnings and revenue. It also reduced the earnings outlook for 2013, which didn't go down too well with investors, and the stock tanked 19%. Comparable-store sales increased 3.1%, and store traffic increased 2.8%.

Though this was the third consecutive quarter of traffic growth, it wasn't good enough to beat analysts' estimates. Revenue grew 13.4% to $364.5 million, missing consensus estimates by 2.8%. Earnings per share were flat year-over-year and missed consensus estimates by 11.5% due to lower-than-expected sales.

The Fresh Market opened 10 new stores during the quarter, a new record for the company. It opened few stores in areas where brand awareness is lower, and this weighed on results. However, third-party market research showed that the customer-conversion rate after spreading brand awareness is good. As a result, The Fresh Market has initiated plans to drive brand awareness, and this should help results going forward.

The Fresh Market has a very robust lease pipeline, which should help with its growth plans. Leases for 27 sites have already been announced, and many other potential sites are in various stages of negotiation. This will provide The Fresh Market with a clear runway for growth into fiscal 2015.

In October, the company witnessed a slowdown in consumer activity, and this is expected to continue in the fourth quarter as well. Hence, the financial outlook for the year was revised downward. Comps are now expected to grow at 3% to 3.5%; operating margin is expected to be inline with the prior year; and full-year earnings are expected to be $1.42 to $1.47 per diluted share.

Whole Foods suffering as well
Whole Foods Market, like The Fresh Market, also gave a negative outlook, and it expects revenue to increase by 11% to 13% in 2014 on the back of a 5.5% to 7% rise in comps. This is a decrease from the estimated 12%-14% growth in revenue as a result of the 6.5% to 8% rise in comps that it had issued earlier.

Earnings per share were also revised downward from a range of $1.69 to $1.72 to a range of $1.65 to $1.69. These downward revisions in guidance didn't go down well with investors, and the stock tanked 9.2% after the results.

These two specialty retailers in the organic- and natural-food market space may not have performed as per analyst expectations, but if we consider the impact of a sluggish economic recovery, these aren't bad performances as such. According to The Guardian, for example, in the U.K. the organic-food market had declined during the recession, and it's only this year that it has picked up by 0.6%.

Kroger's moves
On the other hand, Kroger posted solid second-quarter results. Earnings climbed 17.6% from the year-ago quarter to $0.60 per share. Likewise, revenue increased by 4.6% to $22.7 billion. Kroger has been looking to benefit from the growth of the organic-food industry as well and it is expanding its brands as such.

Its acquisition of Harris Teeter Supermarkets, which is expected to be complete by year-end, would expand its footprint in the Southeast and Mid Atlantic U.S. markets and prove to be accretive to the top and bottom lines.

Kroger is a diversified grocer that sells products apart from organic food and this has helped the company to do well when compared to The Fresh Market and Whole Foods. But adding organic offerings to its stores should add further momentum to its growth.

Bottom line
As competition heats up in organic food, a smaller player such as The Fresh Market is under the risk of getting elbowed out from different angles. There could be price wars going forward as the likes of Kroger and Whole Foods get more competitive.

The Fresh Market is down more than 16% this year and still trades at a P/E ratio of 28, above the 22.5 times industry average P/E. Hence, The Fresh Market doesn't look like a solid investment.

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