Sprouts Farmers Market (Ticker: SFM) - Brief Breakdown
In our Brief Breakdowns, we pick a stock and take opposite sides – one of us presents the bullish argument and the other presents the bearish argument.
Company Description
Sprouts Farmers Market Inc. (NASDAQ Ticker: SFM) is a supermarket chain that specializes in natural and organic foods, including fresh produce, bulk foods, vitamins and supplements, packaged groceries, and much more. Sprouts offers its own variety of products that are minimally processed and free of artificial flavors, colors, preservatives and synthetic ingredients. Sprouts started as grass-roots (pun intended), family-based business, Sprouts has expanded rapidly over the last 5-10 years. After going public in 2013, Sprout began its initial so-called “southern expansion,” adding stores in Florida, Georgia, and North Carolina through 2014 and 2015. As of 2021, Sprouts has grown to > 360 stores across 23 different states and employs ~35,000 people.
Quantitative Analysis
At the time of this writing (5/9/2021), SFM is trading at $25.81 with a 52-week range of 18.21 – 28.63 and a market cap of 3.04B. SFM has a relatively low P/E ratio of 10.97 but this could be due to a 4% decrease of net sales from Q1 of 2020 compared to Q1 of 2021. According to Sprouts 2021 Q1 earnings The comparable store sales growth is -9.4% and the two-year comparable store sales growth is only 2.2%. The net income of Q1 of 2021 is down $9 million and the net earnings per share is down $0.08 when compared to the same time period of 2020. Sprouts’ goals for 2021 include flat lined sales from 2020 to 2021 and expanding by adding 20 new stores.
Qualitative Analysis
Sprouts Farmers Market is at the forefront of all farmers markets and is the largest chain of farmers market stores in the country. As we noted in our breakdown of SunOpta, a recent report by the Organic Food Trade Association the market share of organic food sales relative to total food sales has steadily increased from 3.4% in 2010 to 5.8% in 2019. In 2019, organic food sales amounted to ~$50B USD, up from ~$23B in 2010. Although the industry that Sprouts specializes in has grown, Sprouts has not seen growth within the past year. As Sprouts competes against niche local farmers markets and larger organic food chains, such as Whole Foods who is now owned by Amazon, Sprouts is having trouble building a consistent client base. Fortunately, Sprouts has a large footprint around the United States and plans on expanding in 2021 - hopefully this will lead to brand loyalty in areas that larger retailers have not yet controlled.
Bullish Thesis
Here are three points to support the bullish thesis:
Rapidly Growing Organic Food Industry: In our previous breakdown of SunOpta (ticker STKL), we discussed the rapid popularity growth of organic foods in the U.S. A recent report by the Organic Produce Network showed that organic fresh produce sales continued their decade-long rise, even through a pandemic that may have stressed the wallets of many Americans. This general trend bodes well for Sprouts, so long as they can capture a large enough share of the growing organic food market. However, as discussed below, this will be difficult for Sprouts, as they must compete with local farm-to-market retailers and bigger national food store chains such as Whole Foods.
Commitment to Expansion: As noted above, SFM went from humble beginnings to a national chain with over 360 stores across 23 states in a relatively short period of time. This rapid expansion continued throughout 2020, despite pandemic-related difficulties. Indeed, last year SFM opened 22 new locations, which represents a 6% growth rate over 2019. Leadership at SFM recently revealed a +10% annual growth target through and beyond 2021. They have a track record of successful acquisitioning and merging (for example, in 2012, just prior to going public, SFM purchased Sunflower Farmers Market, a move that forced SFM to integrate 37 new stores). In addition to acquisitioning and merging, SFM has proven its ability to create and maintain new locations. Continued growth through either of these methods will help make Sprouts a more identifiable brand name and will certainly make SFM a more attractive investment opportunity.
Adoption of web-based grocery sales: The COVID-19 pandemic caused a large shift in grocery habits in the U.S. Indeed, in 2020, online grocery sales grew by 54% and represented just under 7.5% of all grocery sales in the U.S. Sprouts outperformed this market-wide growth, achieving an amazing 340% increase in ecommerce sales compared to 2019. This may be due in part to their relatively well-received app. As of this writing, the Sprouts app had an overall rating of 4.6/5 stars (based on ~17k reviews) while the Whole Foods app had an overall rating of 2.3 stars (based on ~2k reviews). If consumers continue to utilize online shopping post-pandemic and Sprouts can continue to bring shoppers a high quality app, they may be able to gain leverage against their more mainstream competitors such as Whole Foods.
Bearish Thesis
Here are three points to support the bearish thesis:
Recovery from COVID-19: According to Super Market News, online supermarket sales reached a new peak in January 2021 of $9.3 billion and ⅔ of consumers reported switching purchase loyalty to less-expensive brands since the beginning of the COVID-19 pandemic. Although grocery store sales soared, Sprouts did not seem to be a store that consumers flocked to. With the recent trend and the unknowns of the recovery from the COVID-19 pandemic, it seems Sprouts will have an uphill battle to regain previous customers and obtain new ones.
Brand Loyalty: Sprouts is attempting to create a national chain of stores that service a relatively niche and local market. Farmers markets typically entail farm-to-market products, where the products are supplied by local farms. Expanding the farmer market concept nationally will be a tall task for Sprouts and failure to do so could ultimately devastate the company. Cultivating a loyal customer base and developing a stronger brand identity are important for Sprout’s success, however these don’t appear to be major goals for the company. With competition on the local level (for example, local farmers markets) and national level (for example Whole Foods), it will be difficult for Sprouts to gain loyalty and carve out the niche clientele it seeks.
Expected Lack of Growth: As laid out in their 2021 Q1 earnings report, Sprouts goal is to have a flat line revenue growth from 2020 to 2021. Scott Mushkin, founder and CEO of R5 Capital estimated in 2018 that 46% and $1.7 trillion of US food spending was for food at home occasions and just two more food-at-home occasions a week would lift that number approximately $130 billion. If Sprouts could obtain just a fraction of that increased food-at-home market share, that would be a substantial amount of revenue for SFM, yet management does not give off a sense of optimism. Some could make the argument that Sprouts could be under-promising with anticipation of over-performance, but after a year rocked by a global pandemic and optimism that within this year the world will return to “normal” it is difficult to understand why management expects no growth.
Learn more about Sprouts Farmers Market here.
Disclosure: The article was written by Daniel Kuhman and Brandon Keys, and it expresses the author's own opinions. They are not receiving compensation for it. They have no business relationships with any company whose stock is mentioned in this article. The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.