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Summary

  • As a business within the gourmet specialty retail industry, investor outlooks have been dampened significantly due to crowding and growing competition.
  • The model has proven to be a success; provided growth numbers stay within the historical range the company is very cheap.
  • With weather improvement and negative sentiment exaggerated, downside should be extremely limited.

Anyone following the story of The Fresh Market (NASDAQ:TFM) knows that the company is a high growth business with store expansion ranging between 23-27 stores annually. Operating cash flow easily covers the expansion so use of debt is nominal. I am not going to break down exactly what they do and have done in the past to become what they are today. This piece is simply meant to articulate anything I believe has been left out that I think is worth mentioning. If you are interested in the additional information, read these two great articles provided here and here.

Observably the industry has become very crowded, so the market tends to believe that sales will likely not keep up and more importantly comps will decline. Additionally, many investors have really honed in on store closings in California presuming this a sign of weak management. The short float is also hanging at it's historical high of 21%, no doubt a sign of severe pessimism. As a contrarian idea, this pick appears to have substantial risk, but it is actually pretty limited after evaluating the fundamentals of the business and its industry. After assessing the financial statements and management's outlook, I think the company is cheap on both an absolute and relative basis.

Valuation

The Fresh Market has implemented a business strategy that has grown revenues by 15% year over year, while comps have sustained a range between 3-5%, as management has suggested in the past. Currently trading at a forward multiple of 16, the market is missing the figure by at least 2 to 4%. In the last quarter, comps rose to 3.5% where management disclosed that these figures actually dip initially but rise overtime. So from this aspect, it seems pretty inefficiently priced. Provided below are the different scenarios that I came up with, suggesting an upside between 30-100%.

On the lower end we have 77 cents on the dollar, or 30% upside to 50 cents on the dollar suggesting 100% upside.

Side-note: Any major improvement or weakness in the growth rate will swing these estimates significantly.

Another investor pointed out that TFM and the S&P500 are trading at 16x multiples. Is it common sense to think these two entities are growing at the same rate? Clearly not, therefore TFM is likely cheap on a relative basis.

Here are some other relative fundamental metrics as well:

Companyp/sp/edebt/eq
WFM1.03220.02
TFM0.94170.12
SFM1.57320.76

Margins and return on equity also hover around the top of the industry. Not to mention, FCF is trading only at a 10x multiple opting out corporate expenses.

Valuation II

I also decided to conduct a scenario analysis looking at earnings power per store, subtracting maintenance expenses from operating cash flow. The spreadsheet is visualized below:

(click to enlarge)

Dividing the outstanding shares, EPS came out between 1.97 and 2.61. After looking over raw data provided by Intangible Valuation, another SA contributor, EPS came out to a narrow range of 2.30 to 2.40.

From there I decided to give earnings a variety of multiples to assess fair value from a conservative, or weak case, to an aggressive or perfect case scenario. I gave EPS a little bit of a larger range between 2.14 to 2.46 (corresponding to the gray sections). The top and bottom figures are outliers and are used more so for illustrative purposes to assess a reasonable range:

I developed a rough fair value range by taking the closest EPS of 2.30 and combining each multiple. For example, looking at the aggressive case, $63.18 was reached by adding $57.44 and $68.93 and dividing by two. The valuation model shows potential fair values through the green bars, the median and average being very close to ~$50.

Last but not least is a margin of safety summary table derived by assuming either ~$40 or ~$52 is likely to be fair value. Here is the raw data:(click to enlarge)

At the current trading price of $30-31, it looks pretty attractive with a margin of safety ranging between 23-42%.

Qualitative Information

Many people state that the store closures were a sign of weak management and displayed a clear lack of market research. However, an acquaintance of mine on SA named PackerFan77 made a good point by saying that it's better for management to close a few stores and operate more efficiently than letting the stores sit there to underperform. My friend who has also done a fair share of equity research on the business believes that after listening to conference calls, management is not only able but also very seasoned for their market cap size (below 2 billion) for reviewing in-depth quantitative information, abnormal to a typical small retailer.

I do not deny that the industry is becoming rather crowded, however market conditions have not changed much between now and several years ago. Surrounding competition such as Whole Foods all the way to more direct competition such as Trader Joe's are well baked into the equation at this point. Every year figures have not wavered from the norm spare the one time expenses of store closures and abnormal weather experienced during the winter months. Seeing that The Fresh Market is a niche business, with non-traditional smaller stores, I do not expect a massive influx of traffic relative to larger corporations and therefore am comfortable with their performance.

Side-note: Management and analysts seem more concerned about rising inflation and growing healthcare costs than market share erosion. Competitive pricing is a default protocol that the company constantly implements and reviews to help maximize consumer traffic, but realistically there is no set range to quantify it. For instance, the company knows that if strawberries were to go from $2.99 to $4.99 per pound, buying would decrease significantly, but knowing that customers would drop from X to Y is almost impossible (considering all the moving parts).

Unfortunately I have never visited a store so I cannot get a real assessment of how customer inflow is. After reading many outside sources, the perspectives seem to be rather mixed. Some people like to believe the store is that of a tomb while others say it's a beehive and frankly I think it will vary between location. All said and done, I think the numbers tell the true story as people tend to incorporate an emotional or cognitive bias (being long or short). So unless the system is ultimately broken, I have a pretty high level of confidence this company is a great investment.

Sentiment

I know it seems rather silly and opinionated to say that a stock is bottoming, simply because we do not know when the majority of the market will say it is a buy or a sell. Although seeing the stock trade below it's initial trading price (near the IPO) while fundamentals have actually improved, I don't see why a rational investor would want to sell the company at this point. To that end I think downside is very limited.

Bottom Line

After evaluating The Fresh Market in pretty high detail, and gathering secondary opinion, I think it has very good potential going forward. Looking at the two valuations methods, the lowest upside potential is 30%. If we scale that out to at least 2 years (shaking out volatility and granting likelihood valuation will be realized), that is 15% annualized, which most would consider to be very good in this type of market.

Source: The Fresh Market: Safety In Numbers

Additional disclosure: I will accumulate more provided the stock price falls.