A couple of years ago I outlined my thesis for why The Fresh Market (TFM) had an unsustainable growth plan and was "grievously overvalued." Despite a worrisome start, my underperform CAPScall on the company has turned into one of my top performers, with the stock plunging 36% since November 2012. Two years later, the company has failed to catch up with the $20 billion gorilla in the room, Whole Foods (WFM), while upstart competitors like Sprouts Farmers Market (SFM 0.47%) have also come on the scene. Read on to learn why I think Fresh Market is still a great stock to sell.
No signs of green growth
When I first wrote about Fresh Market, my two main concerns were that the business's sales growth was untenable, and the stock had become extremely overvalued.
Rather than growing sales by attracting more customers or developing a competitive edge that would allow it to raise prices, the company was simply building more and bigger stores. On a sales-per-square-foot basis, Fresh Market's sales were 20% lower than the industry average, and nearly half that of Whole Foods, its most comparable peer.
That figure has not improved much. Fresh Market averaged $490 per square foot in 2012, compared to an industry average of $531. Fresh Market's sales have improved very slightly from the 2010 figures I originally cited, while the industry average has fallen considerably, but the company is still underperforming. In fact, its most recent sales figures have actually fallen (up-to-date industry average data isn't yet available).
Whole Foods, meanwhile, has pursued a similar strategy of opening new stores, but it has also increased sales per square foot by a wide margin. Whole Foods is also keeping more of those sales. While Fresh Market may have an industry-leading operating margin, it plateaued in early 2012, and Whole Foods' has been steadily catching up.
WFM and TFM Operating Margin (TTM) data by YCharts.
Competition sprouting up
It's tempting to suggest that Fresh Market's inability to catch up with Whole Foods, or even the industry average, may not be its own fault. Sprouts Farmers Market, which had its IPO recently, has a similar business model to Fresh Market, operating smaller-format organic and natural food stores. Sprouts' sales per square foot is roughly the same as Fresh Market's, and hasn't shown many signs of improvement over the last few years.
The average store sizes for Fresh Market and Sprouts are just about 20,000 and 27,500 square feet, respectively. Larger competitors like Whole Foods and Safeway clock in at 38,000 and 47,000 square feet, respectively. Given that the larger stores have higher sales, size may be a factor, but then there's Trader Joe's. Trader Joe's average store size is even smaller than Fresh Market, and its sales per square foot is higher than Whole Foods'.
It may simply be the case that increasing competition is holding down the relative newcomers. Whole Foods can play the small-format game too, and the company has very aggressive expansion plans for the next few years. Meanwhile, conventional players like Safeway and even Wal-Mart are entering the field, with Safeway offering an increasing number of products through its Organics line, while Wal-Mart continues to slowly roll out its small-format Wal-Mart Express stores.
The valuation problem
Despite its lack of internal growth, Fresh Market still has a fairly high price-to-earnings ratio, close to 30. With a PEG ratio of 2.5, Fresh Market's earnings aren't growing nearly fast enough to justify a premium valuation.
It's worth noting that all my original reasoning seems to apply to Sprouts as well, although I'm hesitant to make an outright underperform call on the company, as it timed its IPO shortly after a major acquisition, making it doubly difficult to get an accurate idea of the company's complete operational picture. But by now it's clear to me that Fresh Market's stock is still a sell.
