This Organic Grocer Looks Like a Solid Bet Near 52-Week Lows

Down 30% year to date, this organic grocer reported solid results recently and looks set for robust growth.

May 27, 2014 at 9:13PM

Natural and organic food grocers such as Whole Foods Market (NASDAQ:WFM) and Sprouts Farmers Market (NASDAQ:SFM) have taken a heavy beating this year, down 35% and 30%, respectively. Competition from the likes of Wal-Mart Stores (NYSE:WMT) and other grocers has led to a price war and hurt the prospects of these organic food players. However, in such an environment, Sprouts Farmers Market is executing well on its strategies and could come out of its slump.

Let's take a look at Sprouts' recent results and see why it is positioned for growth.

An impressive performance
The company delivered a solid performance in the first quarter, beating analysts' estimates. Net sales for the first quarter increased 26% from the year-ago period to $722.6 million, beating consensus estimates of $716 million. Revenue was mainly driven by a 12.8% increase in same-store sales, or comps, along with a strong performance by new stores that Sprouts opened. Net income rose to $33.7 million, representing more than a 100% year-over-year jump. 

Sprouts' splendid performance was driven by its ability to aggressively promote fresh produce, which gives it a broad appeal with the every day grocery shopper. A similar performance was seen at its Farmer Sunflower stores, which contributed around 160 basis points to overall comparable-store sales. 

Sprouts' organic, raw, and gluten free products also saw significant sales growth of more than 30% year over year. Sprouts improved its digital strategies by launching a new website, enabling its customers to access the store from anywhere. The new website was enthusiastically received by consumers and registered 1 million page views on the day of the launch. 

Expansion in the cards
Sprouts has opened five new stores, four of which were opened in the first quarter. With the opening of its first Midwestern store in Kansas City, Mo., Sprouts is now operating stores in nine states. It opened this store in January, and it's performing above expectations, driven by consumers' enthusiasm in Kansas and Missouri. This performance demonstrates the strength of its brand and the popularity of the health-related model that it follows.

Sprouts plans to open six new stores in the second quarter, five of which will be in its existing markets and one that will be located in Atlanta, its first store in the Southeast. The company did thorough research of this region, including a review of real estate availability, the labor market, customer demographics, the competitive landscape, distribution costs, and the regional economy. This will be followed by various advertising and marketing strategies in order to introduce the Sprouts brand to the Southeast.

Keeping prices stable is a good move
Cost inflation is an issue that the company needs to tackle. During the first quarter, inflation was around 1%; but Sprouts anticipates higher levels of inflation in the coming months, mainly in meat, dairy, and nuts. In order to keep its customer base intact, Sprouts will pass only a part of this inflation on to the consumers.

This is a good move, as competition in the organic foods space is intensifying with the recent entry of Wal-Mart. In April, Wal-Mart announced that it will be carrying organic food items via the Wild Oats brand; it is looking to make organic food affordable by removing the premium. According to Wal-Mart, customers will be able to save 25% or more with Wild Oats compared to other national organic food brands.

This claim is based on Wal-Mart's item-price comparisons of 26 nationally branded organic products. As such, Sprouts is doing the right thing by trying to keep prices low in order to ward off competition from Wal-Mart. Although Sprouts' gross margin might be pressured as it keeps prices low despite rising costs, this move will help the company increase its customer base. Considering that organic foods represent a high-growth industry, short-term margin pains are affordable, as they will lead to market share gains.

Customers are value-oriented, and it will be difficult for grocers to position organic foods as premium offerings. This is the reason why Whole Foods has been suffering in recent times, as cheaper alternatives are coming into the market. The largest U.S. natural foods grocer has missed analysts' estimates for six consecutive quarters and recently lowered its earnings forecast for the year. Hence, Whole Foods shares tumbled almost 20% after it reported results. The company's revenue and comps have slowed, increasing 9.7% and 5%, respectively, from the prior-year period.

The bottom line
Sprouts' performance has been better than its biggest rival, and its strategies should ensure that it is able to sustain its performance going forward. The company's ability to connect with a broad and fast-growing customer base differentiates Sprouts from its competitors. As such, investors should think of initiating a long position in Sprouts Farmers Market, as the stock is trading near its 52-week low.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Mukesh Baghel has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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