Sprouts Farmers Market (SFM, Financial), which is engaged in the retail of natural and organic food in the United States, is an excellent buy for the long-term. This article discusses the key factors that make Sprouts Farmers an attractive investment option.
Company Overview
Sprouts Farmers Market is a healthy grocery store offering fresh, natural and organic foods at attractive prices. The company offers fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, baked goods, dairy products, frozen foods, natural body care and household items catering to consumers' growing interest in health and wellness.
Sprouts Farmers was recently named one of the top five supermarket chains by Consumer Reports and headquartered in Phoenix, Arizona, Sprouts Farmers Market employs more than 15,000 team members and operates more than 170 stores in nine states.
Key Investment Positives
Highly Underpenetrated Market – The growth story for natural & organic products in the United States has just begun. The US supermarket industry is estimated to be $600 billion in size and natural and organic products constitute just $54 billion or 9% of the industry. Therefore, the untapped potential is huge and the organic & natural products market is gaining traction as health problems, particularly obesity, increases in the United States. From current levels of $54 million, the US organic food market is expected to double to $113 million by 2020.
Strong Growth Plans – Sprouts Farmers, with 2013 sales of $2.4 billion, has a market share of 0.4% within the organic market segment. The market share is expected to improve at a robust pace as Sprouts Farmers plans to add nearly 1,200 stores to its existing 170 stores over the next decade and half. An indication of the robust growth in the organic food market is evident from the company’s growth in the last five years. Sprouts Farmers sales have increased to $2.4 billion in 2013 as compared to $1.2 billion in 2009. Robust sales growth will continue from same stores as well as new store openings over the next 5-10 years.
Growth Outpacing The Industry – In the last five years, US supermarket sales have grown at a CAGR of 2.4% and the US natural & organic food market sales have grown at a CAGR of 12%. Sprouts Farmers growth has outpaced the natural & organic market growth with the company’s sales growing at a CAGR of 18.1%. The company’s sales have been robust as compared to larger players such as Whole Foods Market (WFM, Financial) and The Kroger (KR, Financial). Sprouts Farmers, by undercutting their produce prices, has gained the competitive advantage over peers.
Strong Earnings Growth Will Continue – Sprouts Farmers stock will surge higher as earnings growth remains robust. As per analyst estimates, the company’s earnings growth for 2014, 2015 and 2016 is expected to be 41%, 25% and 32% respectively. With a strong growth outlook for the next three year, Sprouts Farmers is certainly a buy and hold at these levels. The company’s growth will also continue beyond the three years mentioned as the company expands in a grossly underpenetrated market.
Comparable Store Growth Accelerating – Another very bullish indicator for the company is the growth in comparable stores. In 2009 and 2010, the company’s comparable store sales growth was 2.6% and 2.3% respectively. This accelerated to 5.1% in 2011 and further accelerated to 9.7% and 10.7% in 2012 and 2013. This is a clear indication that the company’s stores are increasingly getting popular in the areas they are operating. Comparable store growth will continue to boost the company’s long-term EBITDA margin.
Strong Fundamentals – Companies growing fast can often over leverage and self destruct. Sprouts Farmers has strong fundamentals and the company’s current leverage is also not a matter of concern. As of FY13, the company had a total debt of $311 million. The company’s EBITDA for the same period was $192 million and this translates into a relatively low leverage of 1.6. Considering an annual interest of $38 million, the company’s EBITDA interest coverage was at a healthy 5.1. Also, Sprouts Farmers generated $160 million in operating cash flow, which strengthens the company’s fundamentals as it provides the funding for capital expenditure.
Risk Factors
Sprouts Farmers is likely to grow at a robust pace in a highly under penetrated market. However, larger players such as Whole Foods Market and The Kroger can also change their strategy and cut prices to boost their sales. Even amidst competition, Sprouts Market might continue to grow at a robust pace considering the fact that only 9% of the US grocery store market offers organic & natural products. Therefore, the risk from competition exists, but the impact will be limited in the current market conditions for Sprouts Farmers.
Conclusion
Considering the growth potential, Sprouts Farmers is an attractive buy for the long-term. The company has been successful in its strategy of cutting prices to attract market share and the company’s same store growth presents an encouraging story.
Investors can consider Sprouts Farmers at current levels of $32.9. Since the broad markets look bit stretched, my advice would be to invest in parts to average for any broad market correction, which can impact the stock.
