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This past April, I received a text message from a client asking if I had seen that Fairway Group had gone public. This client, whom I recall having spoken with once before while she was in the parking lot at one of their stores, thinks highly of the company experience. I have kept my eye on Fairway's stock now and then but fail to see the value.

Fairway Group Holdings (NASDAQ:FWM) is a food retailer that has 12 locations in the greater NYC Metropolitan area as of now with plans to open two new locations, one in Manhattan's Chelsea neighborhood in July 2013 and in Nunuet, NY in the fall of 2013.

Fairway specializes in natural and organic products, prepared foods and hard-to-find specialty and gourmet offerings.


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Fairway had been a private corporation up until April 22, 2013 when they issued 15.7 million shares of common stock and raised approximately $158.8 million in net proceeds. Shares now trade on the Nasdaq under the ticker symbol FWM.

Before making an investment decision in Fairway's stock, it's critical to understand 3 things:

  1. Fairway's history as a company
  2. What its recent financial history looks like
  3. Where the $158.8 million in proceeds will go
  4. What will drive its value

Fairway's History

Fairway opened its first store in 1933 in NYC. The next store didn't open until 1995 in Harlem. After that, they opened their first store on Long Island in 2001.

See table below:


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As of now, there are 12 stores and 2 more expected to open in fiscal year 2014.

Fairway's Recent Income Statements

Sales and income since 2009 are as follows:


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Use of Proceeds

Fairway issued 15.7 million shares of common stock on April 22nd. The initial share price was expected to be between $10 and $12 a share but priced at $13. All in all, they netted proceeds of $158.8 million.

Of that $158.8 million, $76.8 million was used to pay dividends, $9.2 million was used to terminate a management agreement and about $8.1 million was use d to pay contractual bonuses. So about $94.1 million of the IPO proceeds went to dividends and other management related fees. That left just $64.7 million left to be used for new store growth expansion and general corporate purposes.

Doing the math on this, there are 12 stores and total revenue was $661.244 million making this about $55.1 million in sales per store for fiscal year ended March 31st, 2013. These stores collectively had a net loss from operations in fiscal year 2013 of $18.1 million or about $1.5 million per store.

While there was a cost of $19.2 million in new store opening costs, even if we take that out, the operating profit for each store then comes to about $92,000 per store. Pro forma basic and diluted shares were 24.959 million as of March 31st, 2013. (pg. 45) There are now 41.38 million shares outstanding.

What Will Drive Its Value

The current share price as I write is 25.07 per share making the market cap $1.037 billion or $86.45 million per each of the 12 stores. This $25 share price is more than double the expected initial public offering price and nearly double the $13 share price it went off at.

The balance sheet as of March 30th, 2013 looks like this:


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Assets are about what liabilities are leaving little room for error.

Fairway has high expectations for growth. In a recent presentation they made at a Jefferies Global Consumer Conference, they included this chart of what their potential outlook for growth could look like.


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While that sounds great, it would be far better if each store was able to both show greater profitability and stronger same store sales growth. Noted in their recent quarter ended March 31st, same store sales, of stores that were opened at least 1 year, were up just 2.4% from same quarter the year before.

This compares to their competitor, Whole Foods (NASDAQ:WFM), who experienced same store sales of stores they consider identical, +6.6% for the quarter year over year. Whole Foods has 348 stores as of April 14th, 2013. They have total sales of $12.52 billion for their last 12 month period. They average about $36 million in sales per store per year compared to $55.1 million per Fairway store.

The big difference is, Whole Foods stores are far more profitable. Whole Foods has net income of $517.57 million over the last 12 months. That comes to about $1.48 million in profit per store. That's about a 4.1% net profit margin.

Conclusion

Investors buying Fairway shares today at $25.07 a share are paying a very big premium to both net tangible asset value and future earnings growth.

Fairway has to prove on two fronts:

1. They need to prove their stores can be more profitable.

2. They need to prove they can gather market share due to the fact that both the industry and location of their business is highly competitive and saturated already.

Given their competitor Whole Foods has shown both greater profitability and experienced substantially higher same store sales increases in the most recent quarter, there is little reason for paying $1.05 billion for 12 grocery stores that have little to no profits and can barely grow same store sales.

At a minimum, I would watch for future quarters earnings reports and see how both margins and same store sales growth are progressing. It will also be good to see what the balance sheet looks like after the IPO proceeds.

In the meantime, without substantial improvements in margins and same store sales, I expect Fairway shares to pull back to at least their IPO price of $13 putting the market cap closer to $500 million.

Source: Fairway Group Holdings: Expect Large Pullback In Price