Earnings reports from last month revealed some interesting trends in the retail sector. Superstores such as Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT) fell flat as seasonal changes disrupted sales. Grocers like Safeway Inc. (NYSE:SWY), SUPERVALU INC. (NYSE:SVU) and The Kroger Co. (NYSE:KR) showed mixed earnings and revenue growth from the previous year. Meanwhile, dollar stores like Dollar Tree, Inc. (NASDAQ:DLTR) evolved into disruptive competitors, and topped sales growth at both superstores and grocers.
Amid all these contrasting trends, the Conference Board recently reported that its consumer confidence index in May jumped to a five-year high of 76.2, exceeding economists’ expectations of 71. This means that Americans are still eager to shop despite budget constraints in Washington. This factor, combined with declining unemployment, indicates that it might be time to visit an industry that performs well when shoppers are optimistic – specialty grocers.
Shopping should be special
Specialty grocers, such as The Fresh Market (NASDAQ:TFM) and Whole Foods Market, Inc. (NASDAQ:WFM), have risen in popularity across the United States over the past few years as affluent Americans have demanded higher quality food than everyday products found at Kroger or Safeway. Simply compare the growth of these retailers in their most recent quarters.
| Same-store Sales Growth (y-o-y) | Qty. Revenue Growth (y-o-y) | Qty. Earnings Growth (y-o-y) | |
| The Fresh Market | 3.0% | 13% | 15% |
| Whole Foods Market | 6.9% | 13% | 20% |
| Safeway | 1.5% (excluding fuel) | 0% | 63% |
| Kroger | 3.0%(excluding fuel) | 13% | 22% |
Source: Quarterly Reports, Yahoo Finance
What distinguishes The Fresh Market Inc (NASDAQ:TFM) from its competitors is its store design, which is modeled after old-fashioned European markets. It sells both perishable and nonperishable items, along with specialty foods and gifts. The company went public in November 2010, and the stock has since risen 127% from its initial IPO price of $22. The Fresh Market Inc (NASDAQ:TFM) is not well-known throughout the United States yet, since it only operates 131 stores in 25 states.
Whole Foods Market, which emphasizes “natural and organic products,” is a more widely recognized grocer, with 349 stores in the United States, Canada and the United Kingdom. The company has been trading publicly for much longer than The Fresh Market Inc (NASDAQ:TFM), making its public debut in January 1992. Although Whole Foods rose to fame on its platform of natural and organic foods, the company has been harshly criticized in recent years for selling unlabeled GMO foods. It has also been criticized for the aggressive promotion of its own brands, which leaves little shelf space for smaller local brands.
By comparison, both Kroger and Safeway sell unlabeled GMO products and aggressively market their own in-house brands, but they have been criticized far less than Whole Foods, since Whole Foods Market, Inc. (NASDAQ:WFM) was once considered the antithesis of a “traditional” grocer.
The Foolish Fundamentals
While some investors believe that the success of specialty grocers like The Fresh Market Inc (NASDAQ:TFM) and Whole Foods is simply the result of clever store designs, smart marketing and creative product placement, both companies have some solid fundamentals to back up their growth.
Forward P/E | Price to Sales (ttm) | Return on Equity (ttm) | Debt to Equity | Operating Margin | Profit Margin | |
The Fresh Market | 26.75 | 1.82 | 39.49% | 21.23 | 7.71% | 4.83% |
Whole Foods Market | 61.28 | 0.78 | 14.61% | 0.74 | 6.71% | 4.13% |
Safeway | 9.78 | 0.13 | 20.96% | 206.04 | 2.48% | 1.45% |
Kroger | 11.25 | 0.19 | 36.87% | 210.70 | 2.88% | 1.55% |
Advantage | Safeway | Safeway | The Fresh Market | Whole Foods Market | The Fresh Market | The Fresh Market |
Source: Yahoo Finance, 5/30/2013
Comparing The Fresh Market and Whole Foods to Safeway and Kroger is a simple matter of comparing growth stocks to value ones. Although Safeway and Kroger look fundamentally cheaper, they are weighed down by much higher debt and lower margins than their smaller rivals.
Both specialty grocers have higher margins, since they offer more expensive food products which are popular with affluent customers in times of economic prosperity. Therefore, the recent upticks in U.S. retail sales and consumer confidence indicate that their pricey forward multiples could be sustainable.
Both The Fresh Market Inc (NASDAQ:TFM) and Whole Foods Market, Inc. (NASDAQ:WFM) have a long ways to go before they catch up to Kroger and Safeway, which have 2,424 and 1,641 grocery stores, respectively.
The Fresh Market Inc (NASDAQ:TFM) intends to open 19 to 22 stores in fiscal 2013. During its earnings release, COO Sean Crane announced that the two new stores it added during the first quarter – in Virginia and South Carolina – “opened at 85% productivity”, which bodes well for future store openings. The company expects its full-year earnings to rise 14% to 19% year-on-year, with same-stores sales rising 2.5% to 4.5%.
Whole Foods Market, Inc. (NASDAQ:WFM) plans to add 15 more stores by the end of the year. The company has a lofty long-term goal of nearly tripling its current store count to 1,000 locations in the United States. It also expects robust earnings growth between 13% to 15% for the full year. Same-store sales are expected to rise between 6.7% and 7.5%.
The continued success of specialty grocers relies on the economy, above all else. While these higher-end supermarkets flourish in times of robust consumer confidence, they decline very rapidly when the economy starts to crumble. A comparison of Whole Foods and Kroger’s stock prices over the past ten years reveals just how vulnerable high-end supermarkets are in a recession.
In conclusion, interested investors should pay close attention to The Fresh Market, since it has all the qualities of a younger Whole Foods Market. The Fresh Market Inc (NASDAQ:TFM) is expanding conservatively, introducing its own private label brands, and successfully cultivating a healthy, alternative image that has proven popular with younger, affluent shoppers. Meanwhile, Whole Foods Market, Inc. (NASDAQ:WFM) is a fundamentally attractive growth stock, but its premium valuations indicate that it could be prone to some wild swings if the market stalls out. In other words, if you believe that the economy is on the path to recovery, invest in specialty grocers. If you think that we’re headed toward a recession, stick with Kroger or Safeway instead.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market.
The article Is It Time to Invest in Specialty Grocers? originally appeared on Fool.com.
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