Is the Fresh and Organic Food Rally Over?

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

After a huge rally over the last couple of years, has the stock market lost interest in the organic food sector? As the market hits multi-year highs, organic grocery sector market leader Whole Foods Market (NASDAQ: WFM) is down 10% from all-time highs and The Fresh Market (NASDAQ: TFM) has plunged the last couple of months. The stock that hit $65 in August has fallen all the way to nearly $45. The organic food suppliers are fairing even worse with both Annie's (NYSE: BNNY) and Hain Celestial Group (NASDAQ: HAIN) down huge from the summer highs.

These moves suggest the fresh and organic food rally might be over. One major reason might be the gains the sector made during the past 3 years. Looking at a long-term chart of either Whole Foods or Hain Celestial and the recent drops appear like blips suggesting more weakness could follow as investors continue to rotate out of a once hot sector.

The fresh and organic food market can be consolidated into two basic sectors: grocery stores and food suppliers.

Grocery Stores

The grocery stores like Whole Foods and Fresh Market not only face more competition from new entrants, but the established grocery chains such as Kroger are also moving more into the organic sector. Not a big surprise after fast growth and strong stock gains.

While Whole Foods hasn't had the major sell-off the other stocks have, it has shown surprising weakness in the last few months, which is a sure sign that investors are rotating into other sectors. The stocks in this sector obtained lofty valuations at the top so it isn't surprising that Whole Foods maintains the most expensive multiples considering the limited 10% sell-off. The stock still trades at nearly 2x the expected 5-year growth rate of 15%.

Fresh Market trades at roughly 27x forward earnings, a reasonable valuation compared to the expected 24% growth rate for FY14 and the five-year growth rate of 23%. The company now has a market cap of only $2.2B compared to the huge $17B for Whole Foods. Analysts do forecast 18% revenue growth in 2014, but the earnings might remain a question after the company missed estimates last quarter. Was that an anomaly or signs of a pattern?

Food Suppliers

The suppliers have been hit hard with both stocks down sharply from summer highs. In fact, Hain Celestial soared to over $73 in September, but it now trades around the 2012 lows. The stock soared on the back of strong earnings, but peaked out as the CFO announced plans to retire. The stock hasn't been able to gain any momentum as the general sector turned as well.

The sell-off has been good for the valuation as the stock now trades for a reasonable 19x forward earnings with analyst forecasts of a 5-year growth rate of nearly 17%. At the highs near $74, the stock traded at nearly 26x estimates.

On the other hand, Annie's dropped due to missing Q3 estimates. The hot IPO from March was approaching breakout levels near $50 until the earnings miss. The stock has rightfully dropped down to $35 after the miss and still trades at 34x forward earnings. Analysts expect a solid 22.5% projected 5-year growth rate leaving the stock at a pricey multiple for a stock that missed estimates so shortly after an IPO.

Fresh Market Expansion Plans

No signs exist that the trend towards the fresh and organic food market has recovered, so investors should look for a stock to buy if the sector continues to remain weak. The Fresh Market has some solid expansion plans and a decent valuation, making it a stock to watch.

The company only operates 129 stores in 25 states. After focusing on the Southeast, Mid-Atlantic, and Midwest the company is now expanding into both California and Texas. This provides investors an interesting ability to invest in a stock prior to moving into the two major retail states.

Whole Foods, on the other hand, has 343 stores in total with 70 in California and another 20 in Texas. For Whole Foods, around 30% of the store base is in those states, highlighting the huge growth potential for Fresh Market. The company has leases for four stores in Houston and several locations in California for next year to kick off that growth phase.

Conclusion

In general, the sector has ridden high for a few years so it won’t be surprising to see a year of underperformance in 2013. The growth in the sector might continue, but the stocks recently lagging the market could be a major warning sign to investors. 

The growth potential in Fresh Market remains strong, as the expansion to a national grocer of fresh and organic food will continue for years. The stock is a lot more reasonably priced after the nearly 30% sell off. The current price of the stock offers a reasonable valuation if the CFO resignation and subsequent earnings miss was a one-time event.

Investors interested in the sector might want to spend the next few months researching the stocks instead of owning them.When the trend turns, investors should snap up the cheaper ones such as Fresh Market and Hain Celestial.


Mark Holder and Stone Fox Capital Advisors, LLC have 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. 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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