The Fresh Market: After A 17% Sell-Off, Risks Remain To The Downside

Dec. 3.12 | About: The Fresh (TFM)

Shares of The Fresh Market (TFM) lost 17% of their value over the past trading week. The specialty grocery retailer reported its third quarter results on Wednesday.

Third Quarter Results

The Fresh Market reported third quarter revenues of $321.5 million, up 22.1% on the year before. Comparable store sales rose 5.6% during the quarter. Growth was driven by a 3.3% increase in the number of transactions, and a 2.3% increase in transaction size. Revenues beat consensus estimates of $318.4 million.

Gross profits rose 26.3% as gross margins increased by 110 basis points to 33.1%. Selling, general and administrative expenses rose 90 basis points to 23.8% on higher pre-opening expenses for new stores. Operating margins rose 10 basis points to 5.6% as gross margin expansion was largely offset by the higher selling, general and administrative expenses.

Net income rose 19% to $10.9 million, with diluted earnings per share increasing 18.5% to $0.23 per share. Earnings fell short of analysts estimates of $0.25 per share.

The Fresh Market opened 6 new stores during the quarter and signed leases for 8 new openings. In total, the company operates 127 stores in 25 states.

CEO Craig Carlock commented on the results, "We are pleased that our strong sales and earnings growth continued in the third quarter. Our comparable store sales grew 5.6%, and importantly, customer transactions grew nicely even as we cycled on solid transaction growth during last year's third quarter."

Outlook

The Fresh Market affirms its full year earnings guidance. Full year comparable store sales growth is expected to come in between 5.5% and 6.5%. Full year earnings per share could increase 25-29% to $1.33-$1.38 per diluted share. Analysts expected The Fresh Market to guide for annual earnings of $1.38 per share.

The full year guidance implies that fourth quarter comparable store sales growth is slowing down even further, to an estimated range between 0 and 4%.

Valuation

The Fresh Market ended its third quarter with $15.3 million in cash and equivalents. The company operates with $46.9 million in long-term debt, for a net debt position of $31.6 million.

For the first nine months of 2012, The Fresh Market generated sales of $959.3 million, driven by a 7.3% increase in comparable store sales. The company net earned $43.5 million, with diluted earnings per share coming in at $0.90. Full year revenues could come in north of $1.3 billion, while earnings could come in at $65 million, or $1.35 per share.

The market currently values The Fresh Market at $2.5 billion. This values the firm at roughly 1.9 times annual revenues and roughly 38-39 times annual earnings.

The company does currently not pay a dividend.

Some Historical Perspective

Year to date, shares of The Fresh Market have risen some 33%. Shares started the year around $40 in January and steadily rose to highs of $65 in November. Shares fell back to $52 as a result of the disappointing results last week.

Between 2008 and 2012, the company grew annual revenues by a total of 50% from $862 million in 2008, to a conservative revenue estimate of $1.3 billion this year. Earnings growth did not keep up with revenue growth.

Investment Thesis

Shares are falling as the company fails to boost net margins. During the quarter, earnings growth did not keep pace with revenue growth, and margin developments are disappointing over the longer term as well. The outlook for the full year implies that same store sales growth in the fourth quarter will be very moderate, between 0 to 4%.

Investors are furthermore negatively surprised by the resignation of CFO Lisa Klinger, who will take a similar position at an unnamed apparel retail company. Her function will temporarily assumed by operating officer Sean Crane until a new executive has been found.

The Fresh Market was sold to the public at a price of $22 back in 2010. Shares have sharply risen from that point in time. The long term prospects of the company look good, but the valuation is not compelling at these levels. Margin expansion is difficult, as the company already generates relatively high net profit margins in a low-margin supermarket industry.

The valuation of 40 times earnings is too high, especially as same store sales growth is rapidly slowing down. Risks remain to the downside at these levels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.