The IPO market, once left for dead, is now back! As of last month, we've seen the most IPO activity since 2007 when 33 companies went public. Year-to-date, the number of IPOs stands at 190, well ahead of this time last year. Let's focus on the 100% IPO gainers or as we call them the "100% Club."
Recent IPOs, including the Container Store (TCS - News), have jumped over 100%, as well as Noodles & Company (NDLS - News), which also traded over 100% higher the day of its IPO debut in July. Potbelly (PBPB - News) was yet another recent IPO 100%+ gainer.
Recent Specialty Retail IPO Valuations
Of course the justification of such one day pops is that the companies' earnings will grow into these lofty valuations.
But with Noodles & Co.'s current EBITDA of just over $30.1MM on a share price that places the company's value at $1.3B (36x EBITDA), the company will need to grow earnings astronomically just to maintain current price levels. (To put this in perspective, Noodles & Co's EBITDA hasn't really grown much since 2010 when its EBITDA was $26.5MM). Needless to say there is a lot of room for downside surprise if these growth expectations are not met.
The Container Store is in a little better shape. With $87.6MM EBITDA TCS's multiple sits near a more manageable 20x EBITDA, but the company also holds a sizeable debt load and has seen its same store sales growth slow significantly as of late.
However, as we discussed on Valentine's Day in our article, "What do Earnings and Icarus Have in Common?" the market (VTI - News) has completely forgotten about earnings during the momentum meltup of the past few years anyways, so it is no surprise that these IPO investors are also throwing earnings to the wind as well.
As more and more IPOs come to market at valuations significantly higher than their market peers, one can't help but also wonder if this is just another sign the stock market has gotten too hot for its own good.
Specialty Grocers also Popped 100%
When Sprouts Farmers Market (SFM - News) went public in August, the organic and health food concept was able to attract enough money to shoot its stock up 100% by the opening of trading, closing 121% higher to $39.86.
Sprouts' story is like so many other IPOs, it all depends on the future growth of its stores, and its valuations show it with a P/E currently in the triple digits.
Other Specialty Grocers include Whole Foods (WFC - News), The Fresh Market (TFM - News), and Natural Grocers (NGVC - News). While Whole Foods has been public for over 20 years, Fresh Market and Natural Grocers also had more recent IPOs.
On 11/5/2010 Fresh Market got a hefty first day pop of 46% above its IPO price. Two years later its stock is now up over 130% from its IPO price of $22 while it still sports a P/E of 36x earnings, and its Cash Flow has actually been declining the last two years.
Natural Grocer's IPO on 7/25/12 also saw a pop of 20% on its debut and has since risen another 100% nearing $40 and also still sporting a P/E near 100x.
Taking a step back fundamentally, the grocer market as a whole can really only grow at the rate of the population (a few % per year). This means in order to meet these growth rates, all these new entrants must eventually steal major market share from the majors such as Safeway (SWY - News), Kroger (KR - News), Wal-Mart (WMT - News), and a plethora of other public and private grocers.
Meanwhile, most of these majors have also started offering their own specialty food sections in an attempt to compete with all the new entrants.
Let's Go to the Tape
Having said all this, for most investors all that should matter is price, and right now price is in an uptrend so longs should stay long, at least for now.
A look at the chart below shows that the trend has certainly been a friend to the specialty grocers and in particular Whole Foods & the ETFs that hold some of these Specialty Grocers. But, caution should now reign supreme as recent price highs are being accompanied by something that hasn't occurred since the last major top in Whole Foods and the markets.
Whole Foods made a new high in 2004 around $24, but then after a pullback went on to make another new high at the end of 2005. However, that new price high was not accompanied by as much momentum, signaling the end of the trend and shown in the bottom portion of the chart.
A similar setup today exists in Whole Food's chart. In 2012 Whole Foods made a new all time high nearing $50, and then it pulled back into 2013. Since then it has also made a subsequent new high, but this time as well it is thus far accompanied by less momentum.
If price falls through the trendline that captures all of Whole Foods gains since the 2009 price low, it will be a sign that once again a new high accompanied by less interest is warning of a significant top in price.
The First Trust Consumer Staples ETF (FXG - News) holds companies such as Whole Foods & Sprouts in its portfolio. Whole Foods actually is its largest holding at 6.8% and is another way to play the Specialty Grocer sector.
FXG is also shown in the chart as it displays similar characteristics to Whole Foods. A breakdown in the high flying specialty grocer stocks, such as Whole Foods, would be a sign that FXG's run is also likely over.
On 9/24 we made a similar observation with financial stocks in our article, "Rough Road Ahead?" when financial stocks were similarly close to breaking down from their long term trend. Since then the Financials Select Sector SPDR (XLF - News) has underperformed the S&P (SPY - News) for the first time since the March market top as investors continue to shift out of financials for other sectors.
A similar breakdown in Whole Food's trend may signal a similar fate of its underperformance going forward.
The ETF Profit Strategy Newsletter uses technical, fundamental, sentiment, and common sense tools to keep investors on the right side of the markets. Right now the specialty retail trend is up, but similar to what happened in 2006 as well as more recently to financial stocks, a break in trend would be a bad omen for the 100% club.
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