Wednesday, March 5, 2014

The Fresh Market: Ignore the short-term bumps and look long-term

The Fresh Market, a specialty higher end retailer of fresh produce, reports earnings tomorrow, March 6th. The stock has been down 40%+ since its peak last year. These numbers are as of close Monday, March 3rd. Below are my thoughts and rationale. 

The Fresh Market (TFM)
Analyst: Peter Eller
Buy Recommendation
Market Cap: $1.638B
Share Price: $33.87

Price Target: $38.96

Company Background: The Fresh Market is a European-style market where mainly fresh produce, meats, and other perishable items are sold in a somewhat open area. Their focus is on the local customer and service, being a smaller store than most supermarkets, who today are becoming bigger and more industrialized. The products they offer are coffee, deli and cheese, candy, grocery & dairy, bulk, prepared foods, flowers, meat, seafood, health & beauty, wine selections, and company brand products. From the ongoing debate with the use of genetically modified organisms in produce, The Fresh Market has a wide selection of organic food. The company was founded by Ray and Beverly Berry who opened their 1st store in Greensboro, North Carolina in March of 1982. They currently have 150 stores throughout 27 states, in which Florida has the highest concentration at 31 stores. Their main regions of operation are: Southeast, Midwest, Mid-Atlantic, Northeast, and West. They became a publicly traded company in November of 2010, and each of their stores averages about $10 million of revenue per year.

Competitive Positioning: Their biggest competitor today is Whole Foods, who offer similar services and options as the Fresh Market. Whole Foods also has a much larger presence across the United States, with 365 locations as of Q3 2013. As of 2012, Whole Foods is ranked #12 in the top 15 for market share of food in the retail sector. Whole Foods also accounts for about 2% of census bureau grocery retail sales, at $12 billion per year. The Fresh Market does not fall in the top 15, with sales substantially lower than Whole Foods. Whole Foods has done a better job of narrowing price gaps than The Fresh Market as of recent, mainly through their promotions program. Though both stores do not have a shoppers club card, they mainly rely on customer loyalty, due to being in a niche market. Whole Foods has done a better job executing this strategy, with cut out coupons and several other specials. The Fresh Market has Tuesday and weekly deals, but are limited to a small number of items.

Financial Analysis: Over the past several years, The Fresh Market has been experiencing rapid growth, building more stores to expand their presence across the US. In doing this, they have kept their capital expenditures high, and forecast that they will grow their store presence 15% for the next few years. For the past four quarters, store construction has accounted for about 90-95% of their capital expenditures. In 2012, they opened 16 new stores, which was the most in any year of the company's history, and plan to complete another record amount of store openings in the 2013 fiscal year; 19 to 22 locations. They also reported record customer traffic, up 60%, from 2012 through the first three quarters of 2013, which was mainly due to the new locations being built. Comparable sales were guided higher at the beginning of 2013 from +2.5% to +4.5% on higher transaction count, basket size, and stable store productivity growth. They have been able to keep their store productivity right in line with the industry average of between 80-90% for the past year, even in some weaker markets where stores are first being built to gain traction. Their full-year earnings per share (EPS) number for fiscal year 2013 has been guided down twice. Initial guidance on the year was $1.51 to $1.58. This was taken down to $1.50-$1.55 on their call in the second quarter, then to $1.42-$1.47 on their call in the third quarter. Earnings per share for the first three quarters of fiscal year 2013 have also declined, from $0.46 in Q1, $0.32 in Q2, and $0.23 in Q3.

Investment Thesis: The Fresh Market is part of a niche market that sells higher end, mainly organic foods geared toward the upper middle class in the US. As we continue to see strength in the overall market, GDP growth, job growth, then there should be enough disposable income to support the sale of higher end goods that consumers can spend on. With a small amount of stores across the US, this will give The Fresh Market room to continue to build their brand, though will bring some short-term setbacks due to expansion of their stores.  

  • Natural and organic foods should continue with double-digit growth over the next several years
  • The natural and organic foods industry has grown about 10% per year since 2000 and is worth approximately $100 billion today.
  • Food deflation: lower year over year prices, the MLCX agricultural index, which closely tracks food inflation, shows a possible risk of deflation in 2014, from inflation in 2010.
    • lower cost items at the store for consumers
  • Perishable food inflation low at 1-%
  • Customer traffic, transaction size, and comps expansion
    • Comps lower in Q3 ‘13 due to macro/political issues, mentioned on conference call
  • Working on promotions, possible buy one get one program
  • ROIC at 15% should accelerate EPS growth
  • More aggressive marketing
  • Reduction of shrink

  • Competitive pressures
    • Mainly Whole Foods, with a market cap 20x and revenues 13x TFM with roughly 2.5x the number of stores.
    • Amazon Fresh (longer-term)
  • New market expansion
    • Disappointing results from new stores in Texas and California could be a sign of things to come
    • Lack of brand awareness
    • Need to execute well and make sure they are entering areas of middle-upper class income.
  • Food prices
    • Currently not a concern with a good year of crops
  • Lack of customer loyalty program
    • Frequent shoppers have little in the way of saving
  • Employee satisfaction
    • Listed as one of the worst companies to work for on
  • Local grocery, discount & dollar stores are still among the most shopped channels for grocery
    • 80-90% versus 70% for specialty stores like The Fresh Market and Whole Foods.
  • Survey for online grocery shopping above 40%, trending higher (2,000 consumers)
  • Affordable Care Act

·         Relative Valuation
o    Due to TFM’s low beta bringing down CAPM and the projected higher rate of revenue growth, along with capital expenditures being very high, a Discounted Cash Flow analysis is showing a negative target, which is not accurate.

o    Below TFM is valued on a relative basis to its closest peers, as well as taking into account analysts most up to date price targets.  

Price/Earnings             $38.34

Future EPS                     $1.43
P/E Estimate                    26.81

Price to Earnings History

Year                 P/E
2010                85.83
2011                41.81
2012                35.68

Competitors                                               P/E
Whole Foods (Weight 80%)                    33.06
Kroger (Weight 10%)                              15.08
Sprouts Farmers Mkt (Weight 10%)         63.55

Competitor P/E                                         34.31

3 year Average (Weight 5%)                    54.44
Current P/E (Weight 40%)                       23.52
Forecast (Weight 45%)                            25.00
Competitor P/E (Weight 10%)                  34.31

P/E Estimate:                                           26.81


Price/Book                      $35.29

Book Value Per Share      $5.24
P/B Estimate                       6.73

Price to Book History

Year                P/B
2010               28.57
2011               16.93
2012               11.95

Competitors                                               P/B
Whole Foods (Weight 80%)                     5.02
Kroger (Weight 10%)                               4.33
Sprouts Farmers Mkt (Weight 10%)        11.61

Competitor P/B                                         5.61

3 Year Average (Weight 5%)                   19.03
Current P/B (Weight 40%)                         5.61
BBG Forecast (Weight 45%)                      6.03
Competitor P/B (Weight 10%)                   5.61

P/B Estimate:                                              6.73


Price/Sales                       $37.20

Revenue Per Share           $27.65
P/S Estimate                         1.35

Competitors                                              P/S
Whole Foods (Weight 80%)                     1.5
Kroger (Weight 10%)                               0.2
Sprouts Farmers Mkt. (Weight 10%)         2.2

Competitor P/S                                        1.44

Current P/S (Weight 45%)                       1.1
Historical Avg. (Weight 45%)                  1.57
Competitor P/S (Weight 10%)                 1.44

P/S Estimate                                            1.35                             


Analyst Mean                         $44.54                    
Jefferies                                    $50.00
JP Morgan                                $48.00
Piper Jaffary                             $50.00
Goldman Sachs                        $45.00
SunTurst                                   $41.00
Raymond James                       $44.00
Oppenheimer                            $34.00
Deutsche Bank                         $34.00
Telsey Advisory Group             $53.00
Sterne, Agee & Leach               $44.00
Stephens                                    $49.00
UBS                                          $48.00
BMO Capital Markets              $39.00


Relative Valuation

Price/Earnings (Weight 35%)                 $38.34
Price/Book (Weight 25%)                      $35.29
Price/Sales (Weight 15%)                      $37.20
Analyst Mean (Weight 25%)                  $44.54

Price Target: $38.96

Upside potential +18.96%

Below, 1 year charts of Current Price, P/E, P/B, and P/S 

Reply or Tweet @Peter_Eller10 for questions or clarification.