It's rare enough to find a retailer that trades at an enterprise value-to-revenue ratio of even 1.0, let alone the 2.17 times of The Fresh Market (NYSE:TFM). Clearly, then, investors are putting a premium on what is one of the few exciting growth stories in food retailing today. While there's a lot to like about this story, including a massively under-penetrated market, accelerating comps and good margins, the bulls seem to have this story well ahead of itself. At these prices, The Fresh Market pretty much has to be the next Whole Foods (NYSE:WFM) to support the implied valuation.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

From Strong to Stronger In Q1
The Fresh Market has certainly found a retailing niche that needed to be filled, and the company is seeing its growth pick up.

Revenue rose nearly 23% this quarter, as comp-store sales rose more than 8%. Not only was this performance better than most sell-side guesstimates (which seemed to cluster between 4 and 6%), but it was also an acceleration from the 7% in the prior quarter. With traffic up nearly 6% and tickets up more than 2%, comp growth looked relatively balanced as well.

Better still, growth is not coming at the cost of margins. Gross margin improved about 80 basis points, and management held that through to the operating line. With that, operating income rose 34% and management exceeded the average estimate by more than 10%.

Where's the Private Label Pressure?
One of the predominant themes in food and food retailing over the past year or so has been the growing influence and market share of private label foods, as financially stressed consumers look to stretch their purchasing power in the supermarket. While that move to private label has helped retailers like Walmart (NYSE:WMT), Target (NYSE:TGT) and Kroger (NYSE:KR) to some extent, comp-store growth in food retailing has been soft.

Yet, here is The Fresh Market with its high single-digit comps. Clearly, this company is not targeting the mass-market shopper, at least not any more than Whole Foods ever has. Instead, this small-format chain built around perishables is targeting those customers with the financial means or motivation to prioritize a relatively good selection of quality produce and meats. While stores like Walmart may talk about their healthy eating initiatives and highlight their produce offerings, it's an apples-to-oranges comparison.

SEE: Evaluating Grocery Store Stocks

Balancing Growth with Cash Flow and the Supply Chain
The Fresh Market is very early in its growth cycle. There are more Walmart stores in California than there are Fresh Market stores in the country, and there are almost twice as many Whole Foods stores nationwide. With the company only just beginning to penetrate markets like California, there are many years of major store growth ahead of this company before saturation becomes a consideration.

While that's all well and good, it forces management into a delicate balancing act. New stores cost money to build and stock, but there are also expenses such as "dead rent" (rent paid before a store is open) to consider. Likewise, no company's supply chain is perfectly elastic; expand too fast and the supply chain can become error-prone, inefficient and expensive. On the other hand, expanding and improving the supply chain costs money, doesn't deliver near-term revenue growth and can compress margins in the short term - none of which goes over well with investors.

What all of that means is that The Fresh Market's management team has to balance the opportunity to boost sales with new store openings with the limits of its supply chain and the limits of its balance sheet. Good management teams manage this, but even well-run operations like Whole Foods and United Natural Foods (Nasdaq:UNFI) (an organic foods distributor) have struggled with that balance at some point.

The Bottom Line
I am not bothered by the thought of competition for The Fresh Market; regular supermarkets know that their bread is buttered down the center aisles (packaged food) and Whole Foods operates a different model. Nor am I even all that worried that the company is going to over-spend its liquidity and stress the balance sheet.

What worries me is the valuation already built into these shares. Even assuming a better-than-market discount rate, The Fresh Market's present valuation already assumes that the company will have roughly the revenue of Whole Foods by 2022 with an even better free cash flow margin. While that may be possible, it's demanding and certainly means that The Fresh Market is nothing like an undiscovered growth story.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  2. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  3. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  4. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  5. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  6. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  7. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  8. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  9. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  10. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  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. 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 >>
  5. 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 >>
  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
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!