Could This Tiny "Farmers Market" Challenge Whole Foods?

Source: Sprouts Farmers Market.

Over the past two decades, Whole Foods (NASDAQ: WFM  ) has gone from a $550 million upstart organic grocer to a $20 billion undisputed leader of the organic-food revolution. Though others have attempted to follow in the company's footsteps, Whole Foods has continued to grab market share of the quickly growing organic and local food movement.

But recently, Sprouts Farmers Market (NASDAQ: SFM  ) , whose very name suggests fresh, local food, has gone public with the goal of bringing a similar service -- with an even larger footprint than Whole Foods -- to Americans.

Can Sprouts succeed where others have failed? Let's look at three key areas to evaluate the company's chances.

Quality of operations
The grocery business can be brutal, with stores only banking two pennies of profit for every dollar spent. Because of that, it's vitally important that a company is run efficiently. There are three different metrics we can look at to evaluate this efficiency. Look at how Sprouts stacks up against Whole Foods on these three measures.

 

Gross Margin

Profit Margin

Sales per Square Foot

Sprouts

29.5%

1.54% 

$471 

Whole Foods

35.52%

3.98% 

$919 

Source: SEC filings, most recent annual report or prospectus.

Admittedly, sales per square feet are a little difficult to evaluate for Sprouts, as the company doubled its footprint within the last year via acquisition. But taking all three metrics into consideration, it's clear that Whole Foods is head and shoulders above Sprouts.

Not only does Whole Foods have a pricing advantage (gross margin) via its brand, but it is also a well-oiled machine with a profit margin that is the envy of the industry.

Leadership
Anyone familiar with the organic movement or conscious capitalism knows about Whole Foods founder and co-CEO John Mackey. He is one of the most celebrated CEOs in the country.

But Sprouts has its own unique story. In 1943, Henry Boney started his Speedee Mart in California. The store grew into a chain, changed names, and in 1999 was sold by Boney's family to Wild Oats. Soon after, Boney's son Stan and grandson Steve started a new chain in Arizona called Sprouts. And in a crazy turn of events, Whole Foods -- which had acquired Wild Oats -- sold the Boney family's original business back to Sprouts in 2007. 

All of this is to say that Sprouts has more or less been a family-run business for three generations.

Unfortunately, that's where the warm and fuzzy stories end; Sprouts' current leadership leaves much to desire. According to Glassdoor, only 33% of employee respondents support the leadership of CEO Doug Sanders, and the average rating for the company is 2.7 out of five stars.

More specifically, employees complain of low salaries and raises too small to make a meaningful difference. Furthermore, they complain of being nickel-and-dimed at every corner -- including having to pay for their own uniforms!

That is in stark contrast to Whole Foods, which -- though it's certainly not perfect -- has much higher ratings (3.5 stars) and is known for its focus on employee development. Specifically, Whole Foods employees are organized in autonomous teams, and management pay is capped at a certain multiple of the average employee's yearly wage.

Growth potential
It is in this area, and only in this area, where Sprouts might have an upper hand on Whole Foods. Sprouts currently has about 160 stores and sees potential for 1,200 nationwide. Whole Foods, on the other hand, has just more than 350 stores and has an end goal of 1,000 stores in North America.

Furthermore, Sprouts achieved a comparable-store sales increase of 9.7% in 2012, while Whole Foods' sales rose by 7.5% in the most recent quarter. From a strictly business-oriented point of view, it appears that Sprouts has more potential for growth than Whole Foods.

Why Sprouts shareholders should worry about Whole Foods
And yet, despite this rosy growth outlook, I still think Whole Foods stock is a better bet today. Currently, Sprouts trades hands at 227 times earnings, while Whole Foods is a much more reasonable 37 times earnings.

But more importantly, if Sprouts is going to meet its expansion plans, it's going to need to expand outside of its home territory of the American Southwest. And as it does that, it will be opening stores in areas where Whole Foods has already established operations.

And as people pay ever more attention to where their food comes from, they'll be more aware of their shopping experience. John Mackey has shown that he knows what it takes to create a truly transcendent shopping experience. Based on the relative employee satisfaction at Sprouts, I highly doubt that its in-store experience will approach what Whole Foods has accomplished.

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Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 19, 2013, at 3:40 PM, bike5389 wrote:

    IMHO both are ok but not Fairway might work in NYC but this will really not be expandable . Study Sunopta STKL and Lifeway LWAY.

  • Report this Comment On August 20, 2013, at 2:22 AM, tomw1000 wrote:

    What this author takes as a strong point for whole foods - its higher margings - is precisely its weak point. Go into any Sprouts Store and compare the prices with those in Whole foods. In a typical basket I buy, whole foods is 30-40 percent higher. For example, on the same day the Hatch chilies were $.89 at Sprouts and $1.50 at Whole Foods for a more wilted product. So WF keeps its margins up with much, much higher prices. In the competition that will occur as Sprouts expands, Whole foods is going to be hard pressed to compete on price.

    The Sprouts model is focused on offering food and vitamins and keeping overhead low. Whole foods, on the other hand, takes the more traditional supermarket approach with a wide range of products that keep overhead higher.

    In fact, the two stores will sell to different market segments - whole foods to the trendy and Sprouts with the more price conscious. But the point is that Sprouts can easily raise its margins by two to three percent without any loss of price competitiveness. Whole foods cannot lower prices enough to complete without wiping out is margins completely. Sprouts won't kill Whole Foods but it will take a significant share of its business where they compete, as has been the case in the Southwest. So instead of one of three areas of advantage, Sprouts has at least two.

    The analysis from MF has been very simplistic on the Sprouts/Whole Foods competition. Perhaps getting more objective commentary from someone who does not own Whole Foods stock is in order.

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