Friday's Top Upgrades (and Downgrades)

Analyst picks a winner (and two losers) in the upscale grocery store segment.

Feb 21, 2014 at 12:47PM

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we're looking at one segment of the market in particular -- grocery markets -- and one analyst that's decided to go shopping: Oppenheimer.

Time to get the groceries?
This morning, analysts at Oppenheimer announced a series of new recommendations in the upscale grocery space, advising investors to buy shares of Whole Foods Market (NASDAQ:WFM), but to leave The Fresh Market (NASDAQ:TFM) and Sprouts Farmers Market (NASDAQ:SFM) on the shelf -- saying those two will only perform about as well as the broader market.

This sounds awfully familiar.

Two months ago, if you recall, we profiled a series of picks in this very same segment, when analysts at Stephens initiated coverage with a "buy" on The Fresh Market (and on Natural Grocers, too, but we won't be talking about them today). Stephens recommended against buying Whole Foods or Sprouts, however. And Stephens was half right.

At the time the analyst made its picks, I reviewed the financials on all four of its chosen firms, concluding, "I wouldn't buy a single one of them." Here's how the picks have worked out so far, relative to the S&P's performance (hint: The S&P 500 is the line up top. The one that hasn't lost investors money):

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But after seeing these stocks lag so badly, Oppenheimer is weighing in today with its opinion that Whole Foods, at least, is now worth buying. (The analyst still isn't keen on the prospects for The Fresh Market or Sprouts.) Is Oppenheimer right? Let's find out.

It still costs a whole paycheck
Whole Foods, Oppenheimer's featured recommendation today, is no cheap stock. Even after its decline, Whole Foods costs "a whole paycheck" for many investors -- 35 times earnings and more than 44 times free cash flow. Debt-free and paying a 0.9% dividend, Whole Foods is arguably the best stock of this bunch. But with a projected earnings growth rate of 17%, it's still vastly too expensive to be worth owning.

Withering on the vine
But Oppenheimer is right about one thing: As overpriced as Whole Foods looks, it's still a veritable bargain relative to the price investors are asked to pay for a piece of Sprouts Farmers Market. This one costs more than 121 times earnings.

Granted, free cash flow at Sprouts is a bit better than the GAAP earnings make it look. But even so, the stock sells for 102 times cash profits, which remains a pricey multiple. Sprouts also carries a sizable slug of debt -- $380 million net of cash -- and it pays no dividend. A projected growth rate of 26% annualized over the next five years still isn't good enough to justify paying these high prices, especially given that there's no dividend to "pay you to wait" while the stock grows into its valuation.

One last stale stock
Last and least, we come to The Fresh Market. At first glance, you might think this one is the best bargain of the bunch, given that its P/E ratio is lower than Whole Foods' (just 22 times earnings), while its projected growth rate is faster (18%). The problem with The Fresh Market, however, is free cash flow -- or the near lack thereof.

Despite reporting GAAP earnings of nearly $70 million over the past 12 months, The Fresh Market's cash flow statements show that the company has in fact generated positive free cash flow of less than $10 million over the same time period -- less than $0.14 in real cash profits for every $1 of reported earnings. This makes the stock arguably the most expensive option in the upscale grocery space, with a price-to-free cash flow ratio of 162.5. It's also got -- you guessed it -- more debt than cash on its balance sheet, and as a putative "growth stock," The Fresh Market, of course, pays no dividend.

Long story short? "Second verse, same as the first." These stocks were all overpriced two months ago, when Stephens tried to recommend them. They're just as overpriced today.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. The Motley Fool recommends The Fresh Market. It recommends and owns shares of Whole Foods Market. Rich Smith has no position in any stocks mentioned -- and thinks some of his fellow Fools buy the craziest things. 

 

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