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History
Nathan and Leo Glickberg created the first Fairway Market in 1954 at 74th St. and Broadway in New York's Upper West Side. Leo's son Howie joined the grocery store in 1974 with a plan to grow it beyond one location. By 2006, Glickberg and his two partners had four stores open and business was booming. While the partners were ready to retire Glickberg wanted to keep expanding. In need of capital, he held discussions with potential investors. Out of this came an offer from Sterling Investment Partners, a Westport, Connecticut, private equity firm. Paying approximately $150 million for majority control, the partners went to work adding stores. Today it has 12 high-volume locations with two more expected in 2013.
Caveat Emptor
This deal was brought to you by a private equity firm. Its only goal is to maximize profits for their investors often by applying significant leverage to ratchet up returns over a relatively short period of time. They're also not immune to using superlatives when discussing their investments. Co-founder and managing partner Charles Santoro said this about Fairway: "With the opening of the four additional stores, Fairway is expected to expand its annual revenue to $1 billion." Sterling felt that eight stores would generate an average of $125 million in revenue per store. As of the end of 2012 it had $483 million in revenue from 12 stores over a 39-week period. Annualized that's $53.7 million per store or less than half its projection. Granted it bought right before the "great" recession, but you'll want to be careful about any PR coming from Sterling Partners. At this point it just wants to realize its investment.
Valuation
If you assume that the underwriters will exercise their option to buy 2.05 million additional shares from some of the existing shareholders, Fairway Market's market cap prior to trading was $563 million and $752 million by the close of its first day as a public company. With total debt of $255 million at the end of 2012 and $29 million in cash, its enterprise value is $977 million while its adjusted EBITDA on an annualized basis is $45.1 million. Put it all together and you've got an enterprise value that's 21.7 times EBITDA.
SEE: 5 Must-Have Metrics For Value Investors
Both Whole Foods Market (Nasdaq:WFM) and The Fresh Market (Nasdaq:TFM) have EV/EBITDA multiples that are 37% lower than Fairway Market. Yet The Fresh Market's EBITDA margin is 410 basis points higher while Whole Foods' isn't too shabby at 9.2%, higher again by 220 basis points. When The Fresh Market went public in November 2010, its stock closed up 46% in its first day of trading. Eventually the excitement wore off after hitting an all-time high of $65.69 in August 2012. Since then it's dropped 40% as of April 17. This for a company that had far more revenue and profits than Fairway Market when it went public and significantly less debt.Capital Expenditures
One area where Fairway Market wipes the floor with its peers is its average net sales per gross square foot. In 2012 on an annualized basis they were $1,114 while The Fresh Market's in 2010 when it went public was $481 or slightly less than half. However, The Fresh Market spends about $210 per square foot when opening new stores compared to $310 for Fairway Market. The Fresh Market expects a new store to payback within four years; Fairway Market expects payback in 2.6 years on average. So, while the payback is 35% faster, the outlay (and risk exposure) is almost four times as great. Add to this the fact that it's not making money despite generating industry-leading revenues per square foot and you have to wonder if it will ever be profitable.
Should You Buy?
There's no doubt Fairway Market have some of the most productive grocery stores in the nation. It's a store I'd probably shop at if I lived in the New York City area. The company estimates it can operate up to 90 stores in the Northeast and 300 across the country. That's 14.4 million square feet of grocery store at an approximate cost of $4.5 billion. To date, with the store opening costs and interest expense associated with its expansion, it's been unable to generate a profit. Until it stops building stores, this situation will never change.
SEE: Earning Forcasts: A Primer
By the time the company pays outs dividends to the pre-IPO shareholders (primarily Sterling) along with various payments typical of private equity deals it will have just $64.7 million to invest in its business. That's the equivalent of four stores. If it's planning to go all the way to 300, it's a drop in the bucket. The pre-IPO investors contributed about $159 million in equity. After the dividend payments, etc., they will have a net investment of $65 million while their shares will be worth $484 million as of April 17. That's an annualized return of 39.7% over the last six years.
Frankly, if you want a grocery store investment, go out and buy Whole Foods, The Fresh Market, Safeway (NYSE:SWY) or Kroger (NYSE:KR). They're alstronger financially and cheaper to own at this point. I'd wait for at least a year to see if Fairway Market can figure out how to make money. Until then, the downside risk is too great in my opinion.
Shop at its stores--but don't buy its stock.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.
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