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FWM: The Art Of Expanding Its Businesses

Jul. 10, 2013 3:44 AM ET
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Elcap's Blog
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This article originally appeared on Elcapitalmanagement.com.

Fairway Group Holdings Corp. (FWM), aka Fairway Market, is one of the high-quality supermarkets headquartered in New York City. According to its latest Form 10-K, Fairway Market started as a neighborhood market in the 1930s, however, after more than eight decades, it has developed into a 12-location high-growth supermarkets, with emphasis on extensive selection of fresh, natural and organic products, prepared foods and hard-to-find specialty and gourmet offerings with a full assortment of conventional groceries, as per description on its Form 10-K. In brief, Fairway Market has the variety seen in premium supermarkets, yet it still keeps the touch of next-door farmers' market.

It has debuted its IPO on April 17, 2013, and received approximately $158.8 million in net proceeds from the IPO after deducting the underwriting discount and expenses related to its IPO, according to its Form 10-K. The stock price of Fairway Market has been on the rise since its first trading day, with 57% increase closing at $27.26, as of July 5th, 2013, as compared to the closing price of its first trading day, $17.35. As Fairway Market has identified its niche in providing highly differentiated one-stop shopping experience, it also identified its direct competitors in the following three different categories within food retail industry.

  • Conventional Grocery: Shop&Shop, Shop Rite
  • Specialty/Fresh/Convenience: The Fresh Market (TFM), Trader Joe's
  • Natural/Organic: Whole Foods (WFM), Sprouts

When comparing the recent stock performance of The Fresh Market and Whole Foods with that of Fairway Market, we can see that FWM has demonstrated strong momentum behind its stock price. It is very interesting to see how Fairway Market has expanded its business and kept the stock price going higher.

First of all, we take a look at FWM's financial statement briefly to see how it has fared during the last few years.

On its balance sheet, we can see that total liability is more than 100% of total assets and it has jumped from 80.39%, as of April 1, 2012, to 100.35%, as of March 31, 2013, which is almost 25% increase on year-to-year basis. This also reflects an increase of 4.55% in current liability. The capital structure like FWM's reveals the strategy of how it expanded the business by engaging long-term debt to provide the funding to infuse its growth. Also, on the income statement, FWM has demonstrated net loss for the past three years, partly due to the periodic cost of both debt and equity financing it has engaged. As for net Capex and depreciation, it has shown up in a visible manner, with 35% and 25% increase, respectively, on year-to-year basis. These activities all supported FWM's growth strategy with a goal to continue expanding its store base. As per its latest Form 10-K, FWM intends to grow its store base in the Greater New York City metropolitan area at a rate of three to four stores annually for the next several years beginning in fiscal 2015.

Therefore, it is expected to see that cash, or the ability to generate cash, plays an important role in FWM's growth strategy. Meanwhile, its current cost structure suggests that gross margin has stayed 32% ~ 33% of total revenue and operating income from operation has been in the red since April 3, 2011. This is combined with what is seen in its statement of cash flow. After its IPO on April 17, 2013, FWM has received $64.7 million after paying off accrued but unpaid dividends from its Series A Preferred Stock totaling $19.1 million, accrued but unpaid dividends from Series B Preferred Stock totaling $57.7 million and other contractual and bonus related fees. This $64.7 million is intended to be used for new store growth and other general corporate purposes, as pointed out in its latest Form 10-K. However, the pressure due from preferred dividends and interest expenses will eat into the same net proceed raised via its IPO. As we can see in the following statement of changes in stock, FWM has consistently accrued preferred dividends at the rate between 12% - 14% annually, whose dollar amount have been around the range of $20 - $30 million annually.

Bottom Line: FWM is in a rapid growth stage now, partly fueled by the expansion of its store base. However, profitability still remains under pressure and investors should watch out for FWM's cash flow.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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