Sprouts Farmers Market: Limited Margin Of Safety At Current Levels

Summary

Sprouts Farmers Market has enjoyed a strong rally over the past two months, up 35% since the end of October vs. a 1% decline in the S&P 500.

The company reported mixed results in its Q3 earnings report in November, with strong growth in quarterly earnings but weaker sales performance than expected.

Based on Sprouts’ hope to accelerate its unit growth rates with a new store format that’s expected to have better unit economics, the growth outlook looks better starting in 2023.

However, with the stock trading at ~14x earnings at a share price of $28.70, I don’t see enough margin of safety to justify paying up for the stock here.

krblokhin/iStock Editorial via Getty Images It’s been a solid Q4 thus far Sprouts Farmers Market ( SFM ), which has trounced the S&P 500’s ( SPY ) performance, up 23% for the quarter and 41% year-to-date. This has been helped by strong growth in annual earnings per share (EPS), with the company placing a higher emphasis on margins the past two years. Based on Sprouts’ hope to accelerate its unit growth rates with a new store format that’s expected to have better unit economics, the growth outlook looks better starting in 2023. However, with the stock trading at ~14x earnings at a share price of $28.70, I don’t see enough margin of safety to justify paying up for the stock here. (Source: Company Presentation)

Sprouts Farmers Market (“Sprouts”) released its Q3 results in early November, reporting revenue of ~$1.51 billion, a 4% decrease from the year-ago period. The decline in revenue was a little surprising given that the company added ten new stores in the period (366 stores vs. 356 stores), with comp sales coming in much lighter than expected, with a 5.4% decline year-over-year. On a two-year basis, the comp sales were also a little underwhelming, down 2.1% vs. industry-leader Kroger ( KR ), which posted ~14% growth on a two-year basis in Q3. Let’s take a closer look at the quarter below: (Source: Company Filings, Author’s Chart)

When it comes to top-line growth, Sprouts’ Q3 results came in lower than planned, impacted by weaker than expected comparable sales growth. The company called out vitamins, deli, and grocery, which were stronger in the period, helped by a more normalized work environment, which boosted demand for the sushi bar, prepared meal solutions, and sandwiches. However, the strength in these categories and a wine refresh could not offset lower traffic, which was the major driver behind lower comp sales growth.

The culprit for the lower traffic can be attributed to Sprout prioritizing margins over sales. This is because the company moved away from ineffective and unprofitable promotions, which led to an increase in coupon clippers and margin erosion. The new focus on its core customer seems to be paying off among that cohort, with a higher average basket relative to pre-pandemic levels, helped by a mix of fewer promotions, inflation, and a favorable mix. However, with a portion of total sales impacted, comp sales have remained under pressure and are expected to remain negative in Q4. The key will be effective marketing to bring new customers into the store if the company wants to fill the traffic gap from its higher-margin and core customer focus.

Based on the Q4 guidance and full-year results, comp sales are expected to give up all of last year’s gains from the elevated demand period, with comp sales forecasted to slide 7.25% in FY2021 at the mid-point. Meanwhile, the outlook for 2022 is for flat comps, which doesn’t inspire a ton of confidence, especially if we consider that the company should be taking some additional price next year. Having said that, the company is likely being more conservative due to the difficult and unpredictable operating environment. So, what’s the good news?

(Source: Company Presentation)

Beginning with unit growth, the outlook for 2022 looks much better, with the company planning to open 25-30 stores. Assuming Sprouts finishes the year with 375 stores in FY2021, this would translate to ~7% unit growth, an acceleration from its two-year average. Notably, the new stores are expected to have a much smaller footprint (23,000 square feet vs. 30,000 square feet), which should provide better unit economics, given that they’ll require lower capex, reduced occupancy costs, and lower operating costs. The hope is that they will have similar sales, which will provide a meaningful boost to sales per square foot. So far, this view appears like it could be correct, with the Phoenix location […]

source Sprouts Farmers Market: Limited Margin Of Safety At Current Levels