Organic grocer Fairway Group (FWM) has been one of the best IPO stories of 2013 — its highly successful offering in mid-April was followed up by a first-day spike of 33%, and shares have gone on to return about 94%.
It’s a growth story, no doubt. FWM jacked up its net sales by 19% to $179 million in the most recent quarter, and EBITDA followed suit, climbing by 24% to $13.5 million. Important to note in those numbers is that net sales actually would’ve improved by 29% if not for the impact of Hurricane Sandy, or so says the company.
After such a heater, though — one not even impeded by the broader market’s past two days of pain — should you buy Fairway, or wait for a cooling-down period? To see, let’s look at the pros and cons:
Compelling Concept: Fairway’s slogan is “Like No Other Market,” and that’s reflected in each Fairway location, which not only offers a wide selection of natural and organic foods, but does so at reasonable prices. It’s S-1 is peppered with examples of its offerings, such as “600 artisanal cheeses” and “135 varieties of olive oil”; “whimsical and informative signs designed to educate customers about the quality, origin and characteristics of our products, and offer tips and suggestions on food preparation and pairings”; and an encouragement of “a high level of interaction among our employees and customers, which results in a more informed, engaged and satisfied customer.” This all goes toward realizing Fairway’s belief that quality will engender loyalty.
Attractive Store Economics: FWM has two store types. One is the urban food, which averages about 40,000 gross square feet. A typical location requires an $16 million investment, the payback is less than two months, and the contribution margins generally reach 17% to 20%. Then there is the suburban food store, which has approximately 60,000 gross square feet and requires a $15 million investment. Sales tend to be lower than an urban store, but the payback still ranges from 3 to 3.5 years, and contribution margins range from 10% to 13%. The overall strong returns are based on several key factors, including high-volume traffic, healthy inventory turn rates and the availability of high-margin specialty items. The company also has a direct-to-store delivery model, which means “farm-to-shelf” time is quick — a vital aspect of dealing with perishable items.
Secular Trends: Many shoppers want an engaging store environment and specialty items. According to a Food Marketing Institute study, about 60% of shoppers do not shop at the store most convenient to their home. These customers tend to have more loyalty. Consumers also are becoming more concerned about healthy living. This often means consumers seek out fresh products, and natural, organic foods. According to the Nutrition Business Journal, from 1997 to 2011, sales of organic and natural foods grew at a 12% rate, and the ramp is expected to be 10% for the next seven years or so. During this time, the vitamin and supplement market is expected to grow about 7% per year.
Small Geographic Concentration: Fairway is a small company, with only 12 locations — all in the Greater New York City metropolitan area. The company has invested heavily in its infrastructure to allow for growth, but the ramp will still be small. FWM expects to add just three locations next year and another four in 2015. Contrast that with Whole Foods (WFM), which added 85 stores last year for a total of 349. While the percentage store growth is actually pretty similar, it means there’s a lot more pressure on Fairway to get each and every launch perfect.
Competition: In a word: intense. Fairway must contend with a variety of direct rivals like Natural Grocers by Vitamin Cottage (NGVC), The Fresh Market (TFM), Sprouts (which recently filed for an IPO) and Whole Foods. Then, of course, there’s pressure from traditional grocers like Kroger (KR) and Safeway (SWY) and increasing grocery presence from big-box retailers Walmart (WMT) and Target (TGT).
Valuation: Fairway’s shares are in the nosebleed seats, sitting at 95 times earnings compared to 29 for Whole Foods, 27 for Fresh Market and 50 for Natural Grocers. And there’s no dividend to fall back on.
Fairway’s brand is hallowed in the New York Area. The company got its start in the 1930s as a fruit-and-vegetable stand on Broadway. Then in the mid-1970s, it moved into natural and specialty foods. It still was a mom-and-pop operation until 2007, when Fairway got a capital infusion from Sterling Investment Parnters. Since then, the company has been making lots of smart moves.
Regardless, Fairway is a small outfit, and store growth will be merely steady for the next couple years, with all the risk that entails. Thus, it probably will be difficult for FWM to maintain its premium valuation.
So should you buy Fairway? No — for now, the cons outweigh the pros.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.