THE HEDGEYE EDGE
Sprouts Farmers Market’s focus on food that is natural, fresh, and organic will benefit from consumers looking to eat healthier as a result of the pandemic. The store features a large produce and vitamin section as seen in the store layout below. Core categories of fresh produce and vitamins are seeing strength from long-tailed changes in customer behavior. Consumers are starting more diets that are plant and protein based. Consumers are also purchasing more produce and cooking more at home – Sprouts’ sweet spot. The pandemic has been the most significant driver of visits and trial.
Jack Sinclair, the new CEO of Sprouts Farmers Market, joined the company from Walmart where he was the EVP of the grocery business. He has recently completed hiring many new members of the management team. Together they are making several changes to the company. One key change is the development of a new, smaller format store. The new store utilizes the backroom more efficiently to have similar sales, lower costs, and better returns. The new format will lead to double digit store growth in the out years. Sprouts Farmers Market can double its store base in its existing as adjacent markets as can be seen in the map of the store footprint.
The new management team is also looking to focus more on local produce to be more of a farmer’s market. Historically the company used promotions in its enlarged produce section to drive traffic to the store. The current strategy is to be less promotional. The current pandemic and increased consumption of meals at home has provided the company an ideal time to execute the change to the strategy. In Q2 same store sales grew 9% while gross margins expanded 450bps.
Sprouts Farmers Market’s new management team is now in place. Management has begun several new initiatives which center around fresh, local produce requiring closer proximity to DCs, more uniqueness and differentiation, less reliance on promotions, and better merchandise margins. The company’s smaller store format with the same sales base drives higher returns. The higher returning store format unlocks an open-ended store growth opportunity.
Sprouts Farmers Market’s HSD% store growth, accelerating SSS, and inflecting margins all at a mid-teens P/E multiple is an attractive anomaly. The balance sheet is under-levered at 0.5x and share repurchases will resume later in the year. As the company proves out the return of its new store format and ramps up the pace of store growth, the multiple will expand. With EPS projections above consensus and modest multiple expansion, we see SFM having 40% upside potential over the next year.
