Specialty-food retailer The Fresh Market (NASDAQ:TFM) came public with a bang in late 2010, pricing far above its initial public offering of $22 per share. Investor excitement centered on the company's participation in the natural and organic segment, an area that generated a 12% compounded annual growth rate from 1997 to 2011, according to the Nutrition Business Journal.
However, post-IPO investors have been singing the blues due to weak cumulative returns, capped by a big share price drop in November 2013 on the back of performance-related issues. So, is the company worth betting on after its recent haircut?
What's the value?
Fresh Market operates a niche chain of 146 high-service neighborhood grocery stores, with an average store size and merchandise mix that is only a fraction of the size of traditional grocery outlets. Like other competitors in the natural and organic segment, the company concentrates on high-quality, perishable products that it can add a unique twist to, like bourbon-marinated salmon and hand-trimmed steaks. The upside of The Fresh Market's strategy is an ability to charge premium prices, thereby generating an operating margin in excess of the grocery industry's historically razor-thin level.
In FY 2013, The Fresh Market continued building on its relatively high growth trajectory, with a 13.2% top-line increase that was the product of higher per-store volumes and a better pricing mix. More importantly, the company was able to hold the line on its operating profitability level, 7.4% in the current year, thanks to the use of inexpensive word-of-mouth advertising from its loyal customer base. The net result has been strong operating cash flow, which has allowed The Fresh Market to up its pace of store openings as it expands beyond its southeast U.S. home base.
Of concern, though, is slippage in Fresh Market's comparable-store-sales growth, a performance that management attributed to weak results at newer stores located outside of its traditional base of operations. In contrast, competitor Sprouts Farmers Market (NASDAQ:SFM) continues to operate at roughly peak performance, reporting a 9.9% comparable-store-sales gain in the current year.
Like The Fresh Market, Sprouts is predominantly a natural- and organic-food purveyor, operating a 167 store network in the Western U.S. that leverages its strength in the produce category and a farmer's market feel to win an increasing volume of customers.
In FY 2013, Sprouts has topped Fresh Market's financial performance, with a 39% top-line gain, aided by rising store productivity and a double-digit expansion of its store network. Its profitability has also gained smartly in the current period, as it generates efficiencies from its prior acquisitions, including its 2012 acquisition of Sunflower Farmers Markets and its 37 associated stores. Sprouts' better profitability has resulted in strong operating cash flow, $117 million in FY 2013, which is allowing it to expand beyond its current eight-state operating footprint.
Trying to catch the king
Naturally, both Fresh Market and Sprouts are trying to catch natural- and organic- food retailing kingpin Whole Foods Market (NASDAQ: WFM), the company generally regarded as the trailblazer in the segment. Thirty-five years after its founding, Whole Foods continues to gain strength from its integrated network of stores, bakeries, and roasting facilities to produce value for all stakeholders, including an almost 1,000% gain for stockholders over the past five years.
Like its competitors, Whole Foods has benefited from a rising volume of customers in FY 2013, reporting comparable-store-sales gains and a 10.4% overall increase in revenue. Of greater significance was the company's ability to build on its already-solid gross margin during the period, due partially to the success of its private-label offerings that now account for 11% of total sales. The net result has been operating cash flow that significantly exceeds its growth needs, which Whole Foods' shareholder-friendly management is using for dividend increases and healthy stock-repurchase programs.
The bottom line
The Fresh Market, as well as competitor Sprouts, came to the public market with lofty growth expectations as a result of the decades-long growth trajectory of industry leader Whole Foods. Despite Fresh Market's recent sell off, investors need to be cautious in the sector, given the rising level of competition from both niche players and traditional grocers' organic-merchandising efforts. As such, investors looking for a sector play need to stick with the best of breed, Whole Foods.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Robert Hanley owns shares of Whole Foods Market. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.