Who Will Win the Grocery Store Wars, the Big Guys or a Newcomer?

Just when you think the grocery-store wars couldn't get any more competitive, Sprouts Farmers Market  (NASDAQ: SFM  ) pops up with an IPO. Sprouts considers itself a specialty retailer of natural and organic foods and products. It offers meats, produce, dairy, juices, baked goods, frozen foods, bulk foods, prepared foods, vitamins, supplements, and herbal concoctions.

What it doesn't offer is just as important, since the 25,000 to 35,000 square foot stores are about half the size of a standard grocery store, such as Kroger (NYSE: KR  ) . You won't find aisles upon aisles of frozen foods, snacks and crackers, cleaning products, laundry detergents, and non-food items.

Safeway (NYSE: SWY  ) considers itself one of the largest grocery-store retailers in the United States. It boasts 1,406 stores in the Southwestern, Western, Mid-Atlantic, and Rocky Mountain regions. Kroger has 2,414 stores in 31 states. Both Safeway and Kroger dwarf Sprouts, which has only 160 stores in eight states, but bigger isn't necessarily better in this case.

Sprouts went public on Aug. 2. So does being a public company agree with Sprouts? It would seem so based on third-quarter results.

Growing strong
Sprouts' sales increased to $633.6 million, a 24% improvement from the third quarter of last year. That growth was  fueled by additional traffic, an increase in the amount of purchases per customer, and additional stores.

The acquisition of the 38 stores of Sunflower Farmers Market in May of 2012 is included in both the third quarter of 2012 and the third quarter of 2013. However, the additional stores will positively impact the full-year results. Additionally, 55 new leases have been signed for 2014. As a percentage, that's a growth rate of 34% in new stores.

This aggressive growth strategy is more than matched in the number of stores resulting from Kroger's merger with Harris Teeter, which gives Kroger 212 new stores. However, as a percentage those 212 stores are only an 8.8% increase. Kroger's sales were $22.5 billion for the third quarter, or $9.3 million per store. Sprouts' sales were nearly $4 million per store, while Safeway sales were $8.6 billion from continuing operations, or $6 million per store.

Consolidation pains
The story isn't so sunny for Safeway, which is consolidating its number of stores. It also announced that it will exit the Chicago market by selling 72 Dominick stores. Its Canadian operations were sold to Sobey's in October. The $5.8 billion in cash from these sales is projected by pay down debt of $2 billion with the remainder going to buy back stock.

Gross margin and operating profits going gangbusters
The gross profit margin for Sprouts shot up to $190.1 million in the third quarter, an improvement of 30% over the same quarter 2012. The $190.1 was 30% of sales. The margin would have been higher but some of that gain was eaten up by higher costs for scarce produce items.

While a store like Kroger is less affected by changes in produce because it sells a wider variety of other items, about one-third of the square footage of a Sprouts is devoted to produce. Consequently, produce price changes impact the company's gross margin more severely. Safeway's gross margin of $2.2 billion declined 36 basis points to 25.8% for the third quarter based on increased shrink expenses offset by reduced advertising. Kroger's gross margin of $4.6 billion improved 4.3%, but was only 20.5% of sales as compared to Sprout's 30% of sales.

Safeway's operating profit of $81.6 million declined 0.9% while Sprout's operating profit of $36.6 million nearly tripled from the same quarter in 2012. Kroger's operating profit was $534 million, or about $220,000 per store, compared to Sprout's slightly more than $229,000 per store. Sprouts handily beat out Safeway's operating profit of $58,000 per store as well.

Can the David of grocery stores challenge the giants?
Safeway and Kroger may be the Goliaths of grocery stores, but their performance is being challenged by Sprouts. The question is if the business model of offering primarily produce, bulk goods, prepared foods, and organic products will continue to attract shoppers when compared to the convenience of one-stop shopping.

I vote yes, and so does Doug Sanders, president and CEO. In the press release announcing the third-quarter results he said, "We are pleased to report another strong quarter, evidence of our customers' desire for fresh, natural and organic food at affordable prices."


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  • Report this Comment On December 26, 2013, at 12:11 PM, djlresearch wrote:

    My concern about Sprouts is they have borrowed money to finance growth and to cash out with dividends. They are not using profits generated internally to pay for new store growth. They use other peoples money but other people seem glad to give it to them. Sprout's sales per sq ft and sales per unit lags far behind similar organic competitors such as Whole Foods and Trader Joe's. They don't own their own facilities and will most likely be paying rent. For me personally, after visiting several stores, and seeing some internal financial data, I've decided to stay on the sidelines and just be a cheerleader. I hope they do well. Its best to compare Sprouts to similar specialty competitors rather than to the plain vanilla grocery boxes like Kroger and Safeway.

    Look for a big article to come out any day now in the Houston Chronicle regarding another Safeway division being sold off. Weak highly leveraged grocery chains will be selling off stores by the bushel over the next couple of years. This is the result of Walmart's Project Impact they implemented about 4 years ago.

  • Report this Comment On December 26, 2013, at 3:52 PM, dayna123 wrote:

    What analysts generally fail to mention is the niche market that Sprouts is going for. Sprouts has a smaller, easy-in easy-out neighborhood model. At least in my city, Albuquerque, Sprouts plants its stores in neighborhoods that love a less expensive, smaller alternative to Whole Foods. Sprouts tends to revitalize neighborhoods by re-habbing existing, empty structures. Neighborhoods seem to adopt Sprouts for their "pick up the groceries after work" store, and people also enjoy walking or riding their bikes from their homes to Sprouts. I live 2 blocks from Sprouts. Very busy place with happy shoppers and employees, I own a little stock. I can see them popping up everywhere, with success.

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