Health Stocks: Are Premium Grocers and Others Worth a Buy?

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There are times when I question whether I made the correct career choice — like when I see job openings for professional craft beer brewer. Upscale grocer Whole Foods Market (WFM) is creating its own in-house beers and needs a proper brew master to lend his expertise. I look forward to sampling their handiwork.

Source: Flickr

It’s a little ironic that Whole Foods — a grocer known for selling healthy, organic food — is branching into something as delightfully unhealthy as beer brewing, but the trend towards healthier eating and the popularily of microbrews are driven by some of the same demographic shifts–and Whole Foods knows its customers well.

Generation X (Americans in their late-30s to very early 50s) and the Millennials (Americans in their early 20s to early 30s) have very different tastes than the Baby Boomers did at the same age when it comes to diet. And the Boomers themselves are changing their habits as they age.

These differences are going to create some clear winners and losers across a broad spectrum of consumer products I’d loosely lump into the “health and wellness” sector: everything from organic grocers to vitamin hawkers at the mall. But success at the cash register won’t necessarily translate to success for shareholders.

Health Stocks — Premium Grocers

Let’s take a look, starting with premium grocers. I wrote about Whole Foods recently, noting that groceries are a rotten business. The business of selling food and basic staples is brutally competitive and tends to have modest margins. There is one big exception, however: Premium or specialty grocers such as Whole Foods, Trader Joe's or HEB's Central Market.

These stores — which often offer organic options and more exotic international or craft fare — have had tremendous success in recent years.  Whole Foods — the only publicly traded upscale grocer of any size or scale — is also the only grocer that can compete with Walmart (WMT) in terms of profitability (see my previous article).

The rise of premium grocers is backed by overlapping macro trends that should have years — if not decades — left to run.

Let's start with the elephant in the room: the aging of America's Baby Boomers. As a generation, the Baby Boomers have been getting progressively pickier in their dietary choices over the past 30 years as the exigencies of age have forced them to take better care of themselves.

Don't underestimate Generation X, either. Generation X's preferences have been the driven force behind the internationalization of American food and for the trendy fusion restaurants that crop up in chic neighborhoods like weeds. The Millennials are starting to make their preferences felt as well, and — like Generation X — they have tended to gravitate towards premium foods to the extent that they can afford them at this stage of their lives.

And finally, you have the issue of rising incomes. For the educated and upwardly mobile — the demographic groups that tend to flock to premium and organic grocers — life in America has never been better. The unemployment rate is only about 4% for Americans with a college degree, and the figure drops to just 2.3% for those with a professional degree.

All of this points to a rosy picture for premium grocery chains. Yet the stock performancee paint a very different picture. Compare the performance of publicly traded premium grocers — Whole Foods, Sprouts Farmers Market (SFM), The Fresh Market (TFM), and Fairway Group Holdings (FWM) — against that of the ultimate common-man's grocer, Walmart. Since last October, Walmart is the only grocer stock that hasn't seen substantial declines. What gives? I have one word for you: valuation.

Company	Ticker	Trailing P/E	Forward P/E	Price/Sales
Whole Foods Market	WFM	32.1	25.2	1.36
Sprouts Farmers Market	SFM	91.7	41.9	2.05
The Fresh Market	TFM	32.7	18.4	1.1
Fairway Group Holdings	FWM	N/A	N/A	0.42
Walmart	WMT	16.0	13.5	0.52

Looking at the price/sales ratio, Whole Foods is almost three times as expensive as Walmart — yes, Walmart, the most successful retailer in history. Sprouts is nearly four times as expensive. The Fresh Market and Fairway are a little more reasonably priced, but they’re far smaller and off the radar for a lot of investors.

So, is the foul odor coming from the produce sector just another manifestation of the momentum stock rout? The high-fliers of the past year have had high-profile faceplants during the past six weeks, with many posting double-digit price declines since the beginning of March.

After the recent declines, are the specialty grocers a buy?

No, or at least not yet. The macro trends are durable and real; of this I have little doubt. But it comes back to the economics of the grocery business. Mainstream grocers have not sat idly while the Whole Foods and Trader Joes of the world have poached their customers. Safeway (SWY), Kroger (KR) and even Walmart have expanded their premium and organic offerings in recent years. And while premium grocers can charge more for their products, this ability has limits. Grocery shoppers tend to be a demanding and fickle lot.

Health Stocks — Casual Dining

OK, so organic grocers are best avoided at current prices. But what about health-conscious casual dining?

A growing, high-margin business that fits the general theme of organic fare is Chipotle Mexican Grill (CMG), which avoids using genetically-modified food in most of its ingredients. Chipotle practically mints money with returns on equity consistently more than 20%. Chipotle also funds its expansion organically via cash flows and not via debt or share dilution.

Of course, Chipotle isn't cheap by any stretch. It currently trades hands at 48 times earnings. The stock has also been in freefall for the past month, down about $100 per share. Investors have been concerned that rising food costs will erode profitability, and they probably will — at least in the short term.

Organic fare isn’t cheap, and Chipotle’s margins have been pinched in recent years due to rising food costs, so Chipotle is raising prices for the first time in three years. The increase will in the range of 3% to 5%, or about 25 cents per burrito.

I don't make a habit of catching falling knives, so I wouldn't recommend buying CMG shares today. But I would be a buyer in the mid-$400s if the share price can stabilize.

Another healthy dining choice to keep your eye on? Try Zoes Kitchen (ZOES), which just recently went public. I always recommend caution when discussing small IPOs (ZOES has a market cap of just $500 million), but the macro trend of healthier eating combined with the recent trendiness of the Mediterranean diet should bode well for the chain.

Health Stocks — Packaged Diets and Supplements

Now that I have you salivating thinking about burritos, what about traditional "health" stocks such as diet products companies Weight Watchers (WTW) and Nutrisystem (NTRI) or vitamin and supplement retailer GNC Holdings (GNC)?

I would stay away from all of these and, if you are so inclined, look for opportunities to short. I'm simplifying, of course, but health-conscious Americans have figured out what should have been obvious years ago — if you eat healthier food, you get all of the nutrition you need. Taking a multivitamin pill with your morning coffee won’t "undo" the negative effects of the Egg McMuffin you ate with it. And recent research has shown that vitamins and supplements have no real health benefits and may actually be harmful if overused.

Demographically, shrink-wrapped diet products — the sort you might see on the Home Shopping Network — are a product for middle and working class Baby Boomers, which is a socioeconomic group that is declining in purchasing power and in economic importance. Generation X and the Millennials have not taken to these products, and I don’t expect them to. They’ve grown up expecting better.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long WMT. Check out his new premium service, Macro Trend Investor, which includes a free copy of his e-book, The New Megatrend Investor: The Ultimate Buy-and-Hold Strategy That Will Make You Rich.