Mixed 2Q for Fresh Market

The Fresh Market, Inc.’s ( TFM - Snapshot Report ) third quarter adjusted earnings of 23 cents missed the Zacks Consensus Estimate of 26 cents by 11.5% due to slower comparable sales growth and high operating expenses. Earnings however improved 18.5% from the prior-year quarter.

The third quarter earnings included impact of 2 cents related to transaction expenses for equity offering (1 cent) and legal settlement costs (1 cent).

The company also maintained its financial guidance for fiscal 2012 and announced the departure of its Chief Financial Officer (CFO) Lisa Klinger.

Quarter in Detail

Total revenue of this specialty grocery retailer increased 22.1% to $321.5 million, driven by comparable sales growth of 5.6% and strong new-store productivity level. However, we note that comparable sales growth was slower than 8% in the second quarter and 8.2% in the first. Revenue slightly beat the Zacks Consensus Estimate of $320 million.

Gross profit expanded 26.3% to $106.4 million in the quarter, while gross margins improved 110 basis points to 33.1% due to expansion of merchandise margins and leverage of occupancy cost.

Selling, general, and administrative expenses (SG&A), including expenses related to the equity offering and legal settlement, increased 27.1% to $76.6 million. As a percentage of revenue, SG&A expenses increased 90 basis points to 23.8% due to higher corporate expenses, including those related to share-based compensation program and incremental store opening expenses.

Operating margins increased only 10 basis points in the quarter to 5.6% as tailwind from solid gross margins was offset by higher SG&A expenses.

Fresh Markets opened six new stores in the quarter including its first store in California. As on October 28, 2012, the company operated 127 stores in 25 states.

Outlook for 2012

Despite the third quarter miss, Fresh Market maintained its financial guidance for 2012.

Fresh Market maintained its comparable store sales growth guidance in the range of 5.5% to 6.5% for 2012 despite expected benefits from the upcoming holiday season due to tough year over year comparison expected in the fourth quarter. Though comparable sales growth are expected to continue to benefit from higher customer traffic and increase in transaction size, the company remains apprehensive about macroeconomic uncertainty.

Operating margins are expected to continue to increase 30 to 50 basis points over 2011 margin of 7.5%, as gross margin expansion will be partially offset by higher operating expenses. The operating margin guidance includes the impact of equity offering and legal settlement costs incurred in the third quarter.

Earnings are expected to range between $1.33 and $1.38, also in line with the prior guidance. The earnings guidance represents an increase of 25% to 30% over fiscal 2011 earnings per share of $1.07.

Fresh Market plans to open 16 stores and relocate one store in 2012. It has already opened 15 stores till date this year and hopes to open its 16^th store in December this year.

Capital expenditure is expected to range between $90 million and $100 million, down from prior guidance of $95 million to $105 million.

CFO Resigns

The company announced in a separate press release that current CFO and Vice President, Lisa Klinger, has resigned from her position, effective from December 7. Lisa will take up a similar position with a private apparel retailer. The company will immediately begin its search for a new CFO and in the meantime Sean Crane, the company's Executive Vice President and Chief Operating Officer will act as interim CFO.

Our Recommendation

We currently have a Neutral recommendation on Fresh Market. The stock carries a Zacks #3 Rank (a short-term ‘Hold’ rating). The company competes with Whole Foods Market, Inc ( WFM - Analyst Report ) , which carries a Zacks #3 Rank.