Losing share in style (SFM)
Sprouts Farmers Market reported Q4 EPS of $.42, beating consensus expectations of $.37. The upside came from better margins. SSS increased 2.9% with an increase in basket size offset by slightly lower traffic and fewer items per basket, a continuing trend. E-commerce sales grew 16.5% boosted by the DoorDash partnership, reaching 11.4% of total sales. Dairy, frozen, grocery, and bakery were the strongest categories.
Not chasing sales
Gross margins expanded 60bps YOY to 36.3% against an easier comparison. Price changes were more in line with cost increases. SG&A increased $24M due to new store openings, marketing spend, labor, and commodity price increases. SG&A was 90bps lower than expectations and leveraged 10bps.
Chip has been conservative
Management’s guidance for 2023 was above consensus expectations. Revenue is expected to grow 4-6% driven by LSD% comp growth. Management expects to open 30 new stores and close 11. Gross margins are expected to be flat to up slightly. SG&A is expected to leverage slightly. EPS is expected to be between $2.41-2.53 without including future share repurchases. For Q1 EPS is expected to be between $.83 to $.87 with SSS growth of 1.5 to 2.5%.
Sprouts Farmers Market SSS trends are the weakest in food retail. According to the company the declines have been in UPT, indicating a significant loss in industry volume in recent quarters. Management said that closing 3% of the store base is a catchup for not wanting to close stores during the pandemic. Grocery has been one of the biggest sales winners during the pandemic and the subsequent elevated inflationary period reducing the need for competitors to close previously underperforming stores. If a massive shift to eating at home and inflating grocery nominal sales by 20% do not make a store viable then it does make sense to close it. The shares benefit from low expectations starting with the top-line, but underperforming peers by a wide margin when the competitive intensity is low is a bad omen.
Waiting on approval (KR)
Kroger reported Q4 EPS of $.99 vs. consensus expectations of $.90. The upside was driven by better margins. ID sales ex fuel increased by 6.2%, above consensus expectations of 4.9%. The Express Scripts termination had a 50bps drag on SSS. Kroger’s store label sales increased by 10.1%. Digital sales grew 12%.
The FIFO gross margin rate ex fuel decreased 1 bp. The LIFO charged increased by $214M YOY. Fuel margins increased YOY for the seventh consecutive quarter as seen below. OG&A leveraged 56bps. Management expects inflation to decelerate throughout the year with the end of the year reaching +4-5% inflation.
The company said it would incrementally “invest” more than $770M in associates in 2023 through higher average hourly rates, healthcare, and training. This is a concession to the unions in order to build support for the Albertsons merger.
Management guided F2024 EPS to $4.45-4.60 based on ID sales growth ex fuel of 1-2% or 2.5-3.5% after adjusting for the Express Scripts business. The 53rd week will add ~$.15 to EPS for the year. Fuel is being planned to be a $200-250M headwind in 2023. The LIFO charge is expected to be $300-350M in 2023. Management believes the merger with Albertsons remains on track to close in early 2024. The merger review process likely keeps a ceiling on the share price until the FTC decides whether to challenge it.
Passing on inflation (UTZ)
Utz Brands reported Q4 EPS of $.15 vs. consensus expectations of $.12. The upside was driven by better revenue and margins. Total revenue grew 17.9% driven by organic sales growth of 15.9% YOY. That represents a sequential acceleration from Q3’s total revenue growth of 16.0% driven by organic sales growth of 12.6%. Price/mix increased by 17.9% while volumes declined by 2%. In the 13-week period that ended January 1, Utz Brands sales at retail increased 14.3% according to IRI.
Adjusted gross margins expanded 220bps YOY to 36.6%, accelerating sequentially from +80bps YOY. Gross margin expansion was driven by price increases, improved mix, and productivity programs partially offset by higher commodity, transportation, and labor inflation. The conversion of IOs shifted 100bps from COGS to SD&A expense.
Management guided 2023 to return to its medium-term growth formula of 3-5% total revenue growth, 4-6% organic sales growth, and EBITDA growth of 6-10%. Trailing leverage ended the quarter at 5.0x and is expected to improve by 0.5x by the end of 2023. Utz Brands’ commodity basket was disproportionately hit by inflationary pressures. Utz Brands is now fully passing on higher COGS as price increases have caught up. The salty snack category has a low penetration of private label, but it has an 800-pound gorilla in Frito Lay that delayed its own price increases due to the contracts and hedges it had in place. The snack category also has flexibility in package size and price ranges making it relatively easier to manage margins when the competitive environment is focused on maintaining margins. Acquisitions and regional expansion are key elements of our Long investment thesis, but the current leverage will limit the former in the near term.
When not if (COST)
Costco reported FQ2 EPS of $3.30 vs. consensus of $3.21. SSS grew 5.8% ex fuel in the U.S. and 6.8% for the total company without fuel and Fx. Traffic increased by 5.0% worldwide and 3.7% in the U.S. Ticket increased 0.2% worldwide and 1.9% in the U.S. Memberships grew 7% YOY and the renewal rate improved by 0.1%. Management said a membership fee increase timing is “when not if.” In February, food and sundries inflation was +HSD% (decelerating from and fresh foods were up low to MSD%, the lowest in nearly a year.
Gross margins expanded 8bps or 9bps ex fuel. Core merchandise margins contracted 6bps. Lapping a LIFO charge contributed 14bps YOY. Management said inflation seems to have improved somewhat with commodity relief. SG&A deleveraged 13bps. Inventories were 2% lower YOY with improvements in the supply chain.
Costco is a Best Idea long. Warehouse clubs are gaining share within food retail. Costco offers its members a compelling value proposition in a time of challenging food inflation. It is taking share and driving customer traffic. The membership fees and overall scale provide unparalleled EPS visibility.
