Which Natural Foods Company Offers the Most Upside?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Personally, I can understand the trend toward natural and healthy foods, which has elevated the share price of competitors The Fresh Market (NASDAQ: TFM) and Whole Foods Market (NASDAQ: WFM) in recent years. Both companies operate supermarkets across the United States with a strict emphasis on natural and organic foods. My lunch today consisted of Whole Foods’ 365 Everday Value brand of organic whole wheat bread, reasonably priced around $4 per loaf, combined with Arrowhead Mills crunchy organic peanut butter. Arrowhead Mills is owned and operated by The Hain Celestial Group (NASDAQ: HAIN). Although this particular 16 oz. jar of peanut butter is more expensive than the store brand, I didn’t mind paying a few dollars more as it tastes better and there are no additives.

Whole Foods Market was founded in Austin, Texas when four local businesspeople decided there was a need for a supermarket focused on natural foods. The first store opened in 1980 with nineteen employees, and current Co-CEO John Mackey was one of the founders. Today, the Company operates an impressive 300+ stores across the United States and the United Kingdom. During its most recent 09/30/12 Fiscal Year end, Whole Foods earned an impressive $11.7 billion in sales revenue and generated $466 million in net income. Total revenue and net income have grown significantly over the past 5 years, and the Company has laid out growth plans that take us well into the future.

Interestingly enough, the Fresh Market got its start only two years after Whole Foods, when founder Ray Berry and his wife, Beverly opened their first store in Greensboro, North Carolina on March 5, 1982. As of this writing, the Fresh Market operates 128 stores in 25 states, and the Company is continuing to expand aggressively into new areas of the US. During its most recent 01/29/12 Fiscal Year end, Fresh Market reached the $1 billion mark in sales revenue for the first time, and generated $51 million in net income.

<img src="http://media.ycharts.com/charts/32b7a9c7515a609a846641a7df442163.png" />

Here’s my take on the two Companies at the present time:

Whole Foods

  • In a previous column, I wrote that the share price of Whole Foods is temporarily being depressed as a result of tax selling. Shares have risen during 2012 from $70.00 in January and reached the $100 level multiple times in October, representing approximately a 40% gain for the year.
  • The Company reported Fourth Quarter Fiscal 2012 results on November 7, reporting $0.60 in earnings per share and $2.91 billion revenue that exactly met analyst estimates. The Company also raised its quarterly dividend by 43%.
  • On November 20, the Company announced its board of directors had approved an additional $300 million in stock buyback authorization.
  • On November 30, Whole Foods announced a special dividend of $2.00 per share, payable to shareholders of record at the close of business on December 10. The size of the payout will be approximately $370 million. I feel these shareholder-friendly initiatives indicate management cares about their stock price, and serves as a testament to the strength of Whole Food’s underlying business.

Fresh Market

  • On November 27, the Company announced the resignation of CFO Lisa Klinger as she decided to pursue an opportunity with a private equity firm.
  • Third Quarter Fiscal Year 2012 earnings were announced on November 28, and Fresh Market did not meet expectations, coming in short on earnings per share. The Company reported EPS at $0.23 vs. $0.26 consensus, while revenue slightly exceeded estimates at $321.5 million vs. $318.67 million. Guidance remains the same at EPS $1.33 – $1.38 for full year 2012.
  • Shares of Fresh Market subsequently fell more than 15 percent from their all-time high of $65.69 and are currently exchanging hands for $52.00.

Two camps have emerged since Fresh Market's earnings disappointment. In the first camp, Deutsche Bank came out and downgraded TFM to Hold from Buy, citing the surprise resignation of the CFO and a slowdown in consumer spending. Cleveland, Ohio based Northcoast Research also downgraded the stock, citing similar reasons.

In the second camp, UBS reiterated a Buy rating, stating it did not feel the resignation of CFO Klinger is a sign of difficulties at the Fresh Market, although it lowered its price target on the stock to $63. William Blair also views the pullback in Fresh Market as a buying opportunity, citing an “expectations reset” and that its view on the Company’s long term growth outlook remains unchanged.

Based on my Wall Street experience, I tend to agree more with the analysts who reiterated their respective Buy / Outperform ratings. Having said that, I recommend investors wait in order to see an additional quarter of financial results before initiating their positions. In the unlikely scenario that there are underlying issues at the Fresh Market, the effect on the share price could be traumatic. The Company will report Fourth Quarter and Full Year Fiscal 2012 results in February 2013.

<table> <tbody> <tr> <td> </td> <td><strong>Fresh Market</strong></td> <td><strong>Whole Foods Market</strong></td> <td><strong>Kroger Co.</strong></td> <td><strong>Hain Celestial Group</strong></td> <td><strong>Industry Average</strong></td> </tr> <tr> <td><strong>Market Capitalization</strong><span> ($)</span></td> <td>2.5 B</td> <td>17.1 B</td> <td>14.1 B</td> <td>2.8 B</td> <td>N/A</td> </tr> <tr> <td><strong>EPS</strong></td> <td>1.28</td> <td>2.52</td> <td>1.36</td> <td>2.19</td> <td>N/A</td> </tr> <tr> <td><strong><span>Price/Earnings</span></strong></td> <td>40.50x</td> <td>37.02x</td> <td>19.28x</td> <td>27.49x</td> <td>17.14x</td> </tr> <tr> <td><strong>Price/Sales</strong></td> <td>1.95x</td> <td>1.48x</td> <td>0.15x</td> <td>1.91x</td> <td>0.56x</td> </tr> <tr> <td><strong>PEG Ratio</strong></td> <td>1.76x</td> <td>2.21x</td> <td>2.09x</td> <td>1.83x</td> <td>1.37x</td> </tr> </tbody> </table>

Trailing twelve month data. Industry averages represent the Retail (Grocery) industry.

<table> <tbody> <tr> <td> </td> <td><strong>Fresh Market</strong></td> <td><strong>Whole Foods Market</strong></td> <td><strong>Kroger Co.</strong></td> <td><strong>Hain Celestial Group</strong></td> <td><strong>Industry Average</strong></td> </tr> <tr> <td><strong><span>EPS Growth</span></strong><span> (MRQ)</span></td> <td>18.53%</td> <td>44.01%</td> <td>83.29%</td> <td>52.49%</td> <td>18.60%</td> </tr> <tr> <td><strong>EPS Growth</strong><span> (TTM)</span></td> <td>249.79%</td> <td>30.52%</td> <td>-29.71%</td> <td>57.02%</td> <td>-1.74%</td> </tr> <tr> <td><strong>Revenue Growth</strong><span> (MRQ)</span></td> <td>22.12%</td> <td>23.64%</td> <td>5.89%</td> <td>25.44%</td> <td>11.05%</td> </tr> <tr> <td><strong>Revenue Growth</strong><span> (TTM)</span></td> <td>10.84%</td> <td>15.74%</td> <td>5.80%</td> <td>27.59%</td> <td>9.31%</td> </tr> </tbody> </table>

Trailing twelve month / Most recent quarter. Industry averages represent the Retail (Grocery) industry.

If I needed to purchase either Whole Foods or Fresh Market today and hold it for the next five years, I would choose Whole Foods. Although the Company currently trades for 37 times earnings, if Whole Foods continues to deliver double-digit earnings and revenue growth, the P/E multiple will come down very quickly. Furthermore, senior management has been in place for many years, and there are no uncertainties similar to the CFO resignation at Fresh Market.

For value investors who simply cannot consider Whole Foods or Fresh Market because the earnings multiple violates one of their fundamental rules on investing, take a look at Cincinnati-based supermarket giant Kroger (NYSE: KR). Kroger is worthy of attention in its own right, as the Company is gaining market share within its store base and the Natural Foods department in its supermarkets is impressive, containing a wide variety of organic and natural foods. The Company has had positive operating earnings trends over the past 5 quarters. In particular, Kroger beat Third Quarter FY 12 earnings expectations on November 29 when it reported EPS of $0.45 vs. $0.43 consensus and revenue of $21.81 billion vs. $21.65 billion consensus. Full year guidance for fiscal year 2012 stands at EPS $2.44-$2.46, and with simple math one can determine the Company has a 10.8x forward P/E. This is at the bottom of its five year valuation range, making Kroger shares attractive for investment at current levels. Kroger also has a 2.25% dividend yield.

Investors focused on growth could also consider an investment in Hain Celestial, which I alluded to in the opening paragraph. This natural, specialty, and snack food company’s products are sold in Whole Foods, Fresh Market, and Kroger stores, as well as my local IGA supermarket. Importantly, Hain Celestial achieved higher earnings and revenue growth over the past twelve months and is significantly less expensive than either WFM or TFM. As Whole Foods and Fresh Market continue opening new stores, Hain Celestial’s goods will line the shelves.

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johnmacris was employed by Northcoast Research Holdings, LLC during 2011. johnmacris has no positions in the stocks mentioned above. The Motley Fool owns shares of Hain Celestial, The Fresh Market, and Whole Foods Market. Motley Fool newsletter services recommend Hain Celestial, The Fresh Market, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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