As I wrote a quarter ago, The Fresh Market (NYSE:TFM) is a highly-valued growth stock in the food retail space, and one where the company is starting to see some real pushback from the market as to the company's margin structure and competitiveness. I didn't expect all of the concerns to get resolved in one quarter, but the company's willingness to increase promotions and accelerate store builds seems to be exactly what the Street does not want to hear right now. As I suspect there's a good chance of these shares getting even cheaper, investors may want to keep on eye on this name as a growth stock increasingly trading at a reasonable valuation.
Second Quarter Earnings Don't Deliver
Although The Fresh Market did basically okay in terms of top- and bottom-line performance relative to expectations, this is a story where analysts and investors are increasingly digging into the details and not coming away very pleased.
Revenue rose 11% this quarter and comp-store growth rebounded to 3.4%. In particular, a recovery in traffic (up 1.8% versus 0.6% in the first quarter) should be welcome given the concerns about comps after the first quarter. 
Margins, though, remain a worry. Gross margin improved 10bp from last year, but slid more than a point sequentially. While store occupancy costs certainly played a role, I think investors are going to be quite troubled by management's comments about more intensive promotion activity – while the increase in revenue sold via promotions was not large (22% versus 21% last year), the Street has really seized on margins as a key topic here. To that end, the company's 19% operating income growth and 40bp expansion in operating margin was below where many analysts were looking. 
Margins Redux
At the risk of belaboring the topic, margin performance and guidance really is taking all of the attention these days. Whole Foods (NYSE:WFM) has made a big deal out of their corporate strategy of “reinvesting” into produce margins, and its latest comp number was quite a bit stronger than The Fresh Market's (7.5%, with 4% traffic/transaction growth). Likewise, Wal-Mart (NYSE:WMT) and Kroger (NYSE:KR) have been aggressively marketing their new emphasis on quality, value-priced produce assortments, and this is really the tentpole for The Fresh Market's merchandising strategy.
But it's not just about what The Fresh Market is selling – it's also about the cost of growth. I don't think it will surprise readers to learn that there are costs involved in opening new stores, as you don't go from opening the doors for the first time to 100% capacity overnight.
Managing growth is a key factor for growth retailers (including The Fresh Market, Natural Grocers (Nasdaq:NGVC), and Sprout (NYSE:SFM)), and while the Street certainly recognizes that The Fresh Market must continue to open new stores to meet its long-term growth targets, there's also a worry that management is going to push too hard and lose discipline with respect to expenses and new store economics. To that end, margin guidance and the accelerated store construction schedule clearly has the Street worried.
The Bottom Line
I am inclined to lean the other way, as I don't believe there is any reason to believe that The Fresh Market has abandoned what was previously a disciplined, returns-focused model for store growth. Now I am a little more worried about competition from Whole Foods and Wal-Mart, and I think management needs to re-prove that it can offer a shopping experience distinct enough to draw in customers even as these rivals improve their pricing and assortment (respectively).
Many growth stories hit bumps along the way, and it looks like The Fresh Market has its own. At this point I believe it's more a “rite of passage” than a sign of future trouble. To that end, mid-teens long-term revenue growth still supports a fair value in the neighborhood of $47 and if this pullback goes too far, I just may pick up shares in what I still believe to be a quality long-term growth story.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center