Stashed into the hottest initial public offering market in years, Fairway Group Holdings received little media hype when the grocery store operator went public in April. And with year to date gains of half the broad market, it is not exactly a frothy stock.
But the company, with its chain of 14 quirky supermarkets with a cult-like following in the New York City area, has not escaped the notice of professional investors. Among fund managers, Fairway ranks as this year's most widely held stock among small companies which went public in the first half of this year.
Fairway has maintained that status even though it has yet to turn a profit and its results missed expectations in the most recent quarter, prompting a 21 percent selloff in early November.
Enthusiasm for the company, with a market value of $800 million, comes in large part from fund managers who see the strong potential of its innovative strategy in the $518 billion U.S. supermarket and grocery store industry.
The chain offers many of the same organic and other high-quality goods found in Whole Foods Market, but at lower prices than at the chain that critics call "Whole Paycheck."
Fairway stores feature organic produce, gourmet cheeses and sashimi-grade tuna alongside the Oreo cookies and Pepsi found in traditional supermarkets.
Fairway's aim is to win over affluent consumers who want to save money, while attracting shoppers of more modest means who can't afford Whole Foods. Fairway charges an average of 11 percent less than Whole Foods for the same items, according to research firm Wolfe Research.
"We believe that Fairway is going to take market share by appealing to shoppers at all income levels," said portfolio manager Clifford Greenberg, whose $5.6 billion Baron Small Cap Fund owns about 1.2 million shares, the most of any mutual fund.
Some 134 mutual funds own Fairway shares, almost double the average for a company of its size, according to Morningstar data. The vast majority of analysts who cover the company have rated it a "buy," and none have consigned it to the "sell" bin.
NEW YORK BET - AND RISKS
Fairway is not the only company to go after Whole Foods, whose shares have soared more than 1,200 percent over the last five years as organic food has become mainstream.
Sprouts Farmers Market, an organic grocery chain that operates more than 165 stores in the U.S. Southwest, went public in August, while Fresh Market Inc, which sells natural foods in the Southeast, began trading in 2010. Fresh Market shares tumbled more than 18 percent Friday after the company lowered its 2013 earnings forecast.
Furthermore, Whole Foods is building stores that will compete with Fairway locations in both Manhattan's Upper East Side and in Brooklyn. Whole Foods co-Chief Executive Walter Robb recently said in an interview he would welcome "that fight" and Whole Foods has been lowering prices with store brands and bulk foods.
As it expands out from New York City, Fairway will also have to contend with Wegman's, which has 88 stores across the U.S. Northeast and is one of the largest private companies in the country. Wegman's formula also merges gourmet and organic foods with value-priced staples.
Fairway's New York focus also comes with risks, said Andrew Wolf, an analyst at BB&T Capital Markets who covers the company. Not only is there the concentration in one economic region, but adverse weather can have a distinct affect on sales. The company's location in Red Hook, Brooklyn, for instance, was closed from October to February after it was flooded during Superstorm Sandy, though it received insurance reimbursement.
The company's same-store sales, which rose 1 percent in its most recent quarter and totaled $183.2 million overall, may decline as it continues its expansion, Wolf added. He estimates that Fairway draws customers from a 10-mile radius compared with a 3-mile radius for other supermarkets. Each new store would cannibalize sales to a greater effect than at other chains, he said.
Fund managers and analysts are largely bullish on the company despite the cutthroat competition because they see it as a strong brand name that can travel outside of the city.
"New York City is a market that's highly fragmented, and there's only a handful of high-quality grocers," said Deborah Hyman, a co-manager of the $162 million Burnham Fund, which bought shares of Fairway this year.
She thinks the company could eventually grow to over 300 stores in the northeast region because it will be able to retain its loyal urban customers if they move out of the city and into the broader New York-New Jersey metro area, which has a population of about 21 million people.
Scott Muskin, an analyst at Wolfe Research, said that "the pullback represents a buying opportunity" in large part because the company has been able to reduce its expansion costs.
Fairway shares closed at $19.33 on Thursday, down 33 percent from a 2013 peak of $28.87 on July 11, but still up 11 percent for the year to date.
Muskin estimates that the company spent $20 million on its first suburban store, in Paramus, New Jersey, in 2009, and it is spending $15 million to build its Lake Grove store in Long Island, which will open next year.
"The lower cost profile should not only drive better returns, but, in our opinion, could open up additional white space for Fairway to grow that may not have been previously considered," Muskin wrote in a recent note to clients.
While Wolf is another a Fairway enthusiast, he sees risks in management missteps. The firm's newest store in Manhattan's Chelsea neighborhood - half the size of other Fairways stores and two blocks from a Whole Foods - has fared worse than expected and management says it has plans to rearrange aisles to boost sales there.
Wolf lowered his 2014 estimates for the company to $56.7 million in earnings before interest, taxes, depreciation and amortization (EBITDA) from $64 million, but noted that it would still represent 19.8 percent growth from 2013. He estimated $77 million in EBITDA in 2015 and a profit of 20 cents a share for the first time.
Overall, analysts polled by Thomson Reuters have a median target price of $27 per Fairway share, a nearly 40 percent jump from Thursday's closing price. Short interest - reflecting bets that the stock will drop - remains very low, at less than 1 percent of total shares outstanding.
Greenberg, the portfolio manager at Baron, recently bought more Fairway shares as the price fell.
"They stubbed their toe a little more than expected in Chelsea, but that doesn't change the opportunity they have in front of them," he said.