Sprouts Farmers Market (SFM) is a Hedgeye Consumer Staples Best Idea Short
Call Details:
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Sprouts Farmers Market is losing share within food retail and is over earning post-COVID19. After beating a low bar in Q3 and raising guidance, the setup for Sprouts Farmers Market is attractive on the short side. Q4 will not have the upside that Q3 did. 2023 will not have price elasticity that 2022 did. The competitive environment is transitioning as in-stock levels return to normal, promotions return, and unit demand growth recedes. Supermarkets are losing share to other food retail channels as consumers look to stretch their food budgets. Sprouts Farmers Market is on our Best Idea Short list.
Grocery same store sales growth has been driven by rising prices. Food at-home inflation peaked two months ago, but will remain elevated. The company's customers are managing the high cost of food by removing an item from the basket. Prices have surged and traffic (according to management) remains flattish. Our analysis suggests traffic trends are worsening and same store sales will come under pressure.
We have several concerns about the share performance from current levels including Sprouts’ ability to recoup traffic lost during the pandemic, increased competitive intensity, and the risk of losing customer occasions without produce promotions. The company is embarking on an acceleration in CapEx spending for new distribution centers and a ramp-up in new store openings which will depress returns as profits decline against difficult comparisons. Management is rolling out a smaller store prototype that they believe can match the existing stores’ sales. The lower cost footprint and higher productivity are expected to enable double-digit store growth. The new prototype and pricing change have not been proven out yet, but management has been signing real estate deals to achieve 10% store growth in the future. Our presentation will include an in-depth analysis of the company's real estate locations, characteristics of the better and weaker stores, traffic trends, which markets new openings are slated for, and what those openings portend for future performance.
At 14x 2023 consensus EPS estimates and 10.2x EV/EBITDA, management must prove out its new store model to see the multiple expand from current levels. Our EPS estimates are now below consensus expectations for 2023, driven by lower SSS and gross margins.
Stay tuned for additional details.
