Sprouts Farmers Market (SFM)
A New Addition: Special Opportunities Portfolio
Key Measures:
Recent Price: $26
52 Week Price Range: $16-$31
EPS FY 2016: $1.00
Shares Outstanding: 150 million
Market Cap: $4 billion
Cash Flow Per Share: $0.91
Price as we publish:Â $26
Organic Food For The Masses
If you are seeking a transformative experience in organic grocery shopping, there is no better place than Whole Foods Market (WFM: $30). However, if $2 for an organic apple leaves you financially challenged, you need to look no further than Sprouts Farmers Market. That organic apple is still going to cost $1.25, but that is simply the cost of healthy living. Pour votre santé!
Looking for a Sprouts Farmers Market, for many people, presents a bit of a challenge. A majority of the stores are concentrated in California and four other western states. The first store was opened in Phoenix in 2002 and since has grown to 245 stores in 13 states. (Whole Foods has more than 435 stores nationwide)
While both Whole Foods and Sprouts specialize in organics, healthy lifestyles and great service, this is about where the comparison ends. The average Sprouts is 30,000 square feet, far smaller than Whole Foods or for that matter, the average Kroger store. Sprouts’ focus is more limited, concentrating on fresh foods, produce, meat and seafood, grocery, vitamins and body care. The emphasis is on products where inventory turnover is high. Â
Sprouts stores are well located, merchandised like an open-air farmer’s market, and offer middle of the road pricing on organic products. Sales of bulk items also add to the value perception. With a value-oriented pricing structure, stores are jammed with a growing legion of repeat customers purchasing everyday items. As the table below illustrates, the formula works. Sprouts is the most profitable of the three leading grocery chains.
| Leading Grocery Chains | |||
| Whole Foods | Sprouts | Kroger’s | |
| Sales | 100% | 100% | 100% |
| Cost of Sales | 66% | 71% | 79% |
| Gross Margin | 34% | 29% | 21% |
| SG&A | 29% | 22% | 17% |
| Operating Margin | 5% | Â 7% | 4% |
Industry Background: Organic Foods Are Now Mainstream
The world is no longer going organic; it has arrived. Sales of organic food and non-food products in the United States totaled an impressive $44 billion in 2015, up 11% from the previous year. Organic sales now equal some 5% of the total food market. The Organic Trade Association forecasts that these trends will continue at a double-digit pace through 2018. Organics are good for the health of the consumer and just as good for purveyors of these wholesome goodies.
The Market Is Evolving into Price Segments
Customers expect to pay premium prices for farm fresh and organic products. A $2 chicken that is released from a cage and allowed to run around the barnyard can fetch a price of $15. Everyone can agree on the merits of good health, but not everyone can afford a barnyard chicken.
The market is evolving into different price segments similar to other consumer products like autos and general merchandise retailers. While Wall Street may think in terms of there being intense competition between Whole Foods and Sprouts, we see things differently. Just like other consumer markets, organic foods are evolving into different price categories. A car is just a car, but Mercedes Benz sells to a different demographic and income profile than Ford. Whole Foods is on top but there are a lot more potential customers driving Mustangs.
Well-Executed Growth Strategy
Things are happening at Sprouts. Over the past three years, revenues have grown an average of 21% annually while per share profits increased from $0.37 to $0.83. With 70 new stores being added, a gain to the base of nearly 50%, this has driven this impressive performance.  But there is more to the story. Same store sales increased an average of 9% showing the world that the Sprouts formula is creating loads of repeat business and lots of raves on social media.
Sprouts Farmers Market
| 2015 | 2014 | 2013 | |
| Revenue | $3,600,000 | $3,000,000 | $2,400,000 |
| Net Income | $130,000 | $108,000 | $51,000 |
| EPS | $0.83 | $0.70 | $0.37 |
Solid Outlook
In parts of the United States it may not be easy to find a Sprouts Farmers Market, but Wall Street is rapidly getting acquainted. The consensus of 18 followers is for the company to grow an average of 15% a year over the next five years. That places Sprouts at the top of the heap by any comparison.
Management guidance for 2016 is for revenue growth of 18% and profits up 20% to $1.00. Once again, growth is coming from a balance of 5% same store sales growth and new store openings. Many of these will be in states where clustering near existing stores will lower costs. Skeptics will point to the slowing in projected same store growth. They are quite right up to a point. But at 5% same store growth, Sprouts will lead the industry in this measure.
The Sprouts Farmers Market concept enjoys a broad audience and a loyal following. The challenge is for management to replicate its successful formula in other parts of the US as well as Canada. This involves major investments in hiring and training of personal. Sprouts is on the case, spending wisely to develop future store managers. Â
Financial Performance Is Exemplary
The balance sheet sports $145 million in cash against long-term debt of $160 million. Cash flow from operations generates over $100 million. The balance sheet has improved, owing in part to the 2013 IPO that raised $350 million that was used to pay down debt. For a company of its size, growth and history, this is an A+ situation.
More impressive is the level of management’s attention to detail. During a period of extremely rapid new store openings, inventory turnover, the key to grocery store profitability, remained at high levels throughout. The other standout item: Following the rush of liquidity from the 2013 IPO, the company’s game plan remained consistent. You have to respect their management, as they kept a level head after receiving a check for $350 million. It would have been easy to go on an accelerated spending spree.
BMR TAKE
We love to find companies with great long-term growth potential and Sprouts fits the bill. Now in only 13 states with a proven formula for success, there is no limit to the future that realistically includes three times the number of stores in twice the number of states. This is a conservative projection. The stock is selling a 25 times 2016 profit forecasts compared with the overall stock market valuation of 23. This is the best level of value that the company has ever had in their short history of public ownership. Â