The Fresh Market Too Rich For My Blood

Shares of North Carolina-based upscale grocery chain, The Fresh Market (NASDAQ: TFM) popped almost 11% Wednesday after a strong earnings report and a positive profit outlook. Should you add it to your portfolio?

Results for The Fresh Market's second quarter were ahead of expectations. Its net income of $10.5 million was 52% above the same quarter in 2010 and its EPS of $0.22 beat expectations by a penny. Meanwhile, its revenues were up 13.6% to $259.5 million.

Is this quarterly performance enough to get you to invest? No. But here is one reason to consider it:

• Consistently good earnings reports. The Fresh Market has been able beat analysts’ expectations in each of its last three quarters.

Three reasons to hesitate:

• Expensive stock. The Fresh Market ’s price-to-earnings-to-growth ratio of 4.32 (where a PEG of 1.0 is considered fairly priced) means its stock price is very expensive. It currently has a P/E of 80.4 and its earnings per share are expected to grow 18.6% to $1.24 in 2012.
• Increasing sales and profits but cash poor balance sheet. The Fresh Market has been increasing sales and profits. Its revenue has grown at a 20.6% annual rate from $460 million (2006) to $974 million (2010) while its net income has increased at a 4.7% annual rate from $20 million (2006) to $24 million (2010) — yielding a slim 2% net profit margin. It's debt has fallen from $130 million (2008) to $82 million (2010) while its cash declined from $6 million (2008) to $4 million (2010).
• Out-earning its cost of capital but getting worse. The Fresh Market is earning more than its cost of capital – but it’s getting worse. How so? It’s producing negative EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, The Fresh Market's EVA momentum was negative 2%, based on six months’ annualized 2010 revenue of $933 million, and EVA that fell from six months’ annualized 2010 $45 million to six months’ annualized 2011 $27 million, using a 10% weighted average cost of capital.

At its current valuation, The Fresh Market is way too rich for my blood and it needs to tighten its control of expenses and boost its return on capital. I doubt it could boost earnings growth enough to justify such a high P/E but I might consider it again if the price comes way down.