|Shares Out. (in M):||42||P/E||0.0x||0.0x|
|Market Cap (in $M):||603||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||195||EBIT||0||0|
I recommend a short position in Fairway Group Holdings (FWM) for a potential return of 24-60%. FWM is a grocery chain focused on selling fresh produce, organic products, and conventional groceries in the New York metropolitan area. FWM’s former PE sponsors, Sterling Investment Partners, took FWM public in April 2013. Sterling and the management team used the IPO proceeds to pay preferred stock dividends and raise cash to finance expansion. FWM has positioned itself as a specialty food seller on the cusp of a fantastic growth story buy tying itself to the nascent, but crowded organic food trend. The bloom is off this organic rose and the market has steadily and swiftly knocked the stock from $25 down to $14.49 since it reported a pedestrian 1% same store sales comp on November 7th. The stock is down 20% YTD (it has sold off much faster than I could put together a write-up) and is 10% from its IPO offer price (priced at $13 and closed at $17.35). Despite the recent price action, FWM is still priced for perfection, but its growth prospects are not as alluring as they might initially appear.
Depending on which press release you read, Fairway was founded in 1933 (according to SEC filings) or 1940 (according to media articles regarding Sterling’s acquisition in 2007) by Nathan Glickberg on Manhattan’s Upper West Side. Sterling bought an 80% stake in early 2008 for approximately $150MM with an eye on expanding beyond the company’s four stores. Today there are fourteen stores in New York, New Jersey, and Connecticut, and the company plans on opening four more stores by the end of 2015. Sales per square foot has steadily fallen as FWM has expanded to locations with larger footprints – urban formats are approximately 40,000 sq ft (gross) and suburban formats are approximately 60,000 sq ft (gross). This trend will continue to adversely affect comps and FWM’s growth trajectory.
Growth – Without the Hormones
Although FWM has reported 17-20% annual revenue growth, this growth is driven by new stores. Existing stores very much resemble other grocers with their 32% gross margin (WFM = 36%, SFM = 30%, TFM = 34%) and 1-1.5% comps. It is unclear why FWM should trade at such a higher forward multiple (37x):
Perhaps it is their growth plan, which Charles Santoro, the chairman and Sterling partner, so modestly described in the Q4 conference call:
“Since 2007 we believe we have approximately tripled our market share in this area and still have an extremely large runway for near-term growth representing potentially multiple times our current size. Our broader surrounding market from Boston to Washington DC represents some 65 million people and approximately one-quarter of all US GDP. We believe we can successfully operate at least 90 stores in this Northeast corridor alone comprising a potential $4 billion to $5 billion market opportunity for Fairway. Longer term we believe our Fairway brand and differentiated platform has very strong national appeal.”
He probably also mentioned India and China, but maybe the COO put his finger on the mute button? Capital intensive businesses predicated on distributing perishable (farm-to-shelf!) products do not scale easily or quickly. In fact, FWM only just recently signed a lease to build a central production facility in the Bronx.
So where is FWM building their stores? FWM is pursuing a two-pronged strategy of selling into urban neighborhoods like Chelsea and Hudson Yards (near the High Line for those familiar with the area) and up-and-coming middle class suburban neighborhoods. The recently opened (Oct 2013) Chelsea store has not exactly panned out as management imagined. Although they are pleased with the transaction count, the average basket size is quite low and seems to be used by the grab-and-go crowd. The high turnover is good for the business, but optimizing the SKU count and product mix will be a near term challenge and likely weigh on sequential comps.
Back to the suburbs. The suburbs present the obvious and inevitable growth opportunity, but the New York metropolitan area is an exceptionally competitive region. In addition to conventional grocers that generally don’t operate in urban areas, better capitalized and stronger brands (e.g. WFM) have already scouted and leased the best real estate. I mapped out Whole Foods’ tri-state area stores and you will notice that they have surrounded NYC and are already in towns with the demographic profile most likely to eat fresh produce and organic food: