Sprouts Farmers Market: Health and Value Driving Profitable Growth

In the very competitive organic and fresh food segment, Sprouts Farmers Market (NASDAQ: SFM  ) continues to outpace the industry by delivering healthy food at a value to the consumer. While the company doesn't focus as much on the expensive side of organic foods, it is delivering huge growth from pulling in everyday grocery shoppers that don't want the more expensive products from Whole Foods Market (NASDAQ: WFM  )

Companies in the sector, including The Fresh Market (NASDAQ: TFM  ) , have all been hit hard recently. At these times, investors need to focus more on the substance of the earning reports and less on the headlines and stock gyrations. Large stock dips can offer attractive entry points.

Massive comps
The large sell-off from Whole Foods Market following its earnings results was more due to a misconception of growth rates than actual negative results. The organic leader saw comp sales, sales at stores open at least one year, grow a very solid 4.5%, but this was down from previous higher levels and expectations.

Sprouts Farmers Market continues to see substantial growth driven by a 12.8% increase in same-store sales. The gains for the quarter came almost equally from a combination of more traffic and increased basket size. The ability to obtain a 6% increase in basket size from existing customers while also attracting an expanded customer base bodes well for the future.

Sprouts is only now entering major markets such as Kansas City and Atlanta, and now counts nine states in its store base. The store base sits at only 172 locations, which means it has room to grow considering Whole Foods' forecast for 1,200 stores in the U.S. alone.

Margin squeeze
While the main competitors in the organic space continue to see margin pressure, Sprouts is taking share from traditional grocery stores. The focus on the middle-income customer base is allowing the company to increase margins and grow its basket size, or the amount each customer spends on average.

The company grew its gross margin to 31%, an increase of 70 basis points compared to the same period in 2013. The margins are unfavorable when compared to Whole Foods and even The Fresh Market, but the numbers are heading in the right direction.

Whole Foods saw a small squeeze with gross margins declining to 35.9%, but it's still higher than the same periods in 2010 and 2011. The one reason that Whole Foods' stock plunged 20% following earnings and is now down substantially from the $65 high achieved back in October is the concern that the leading organic grocer will have to continue reducing prices, potentially hurting its margins.

In the last reported quarter that ended in January, The Fresh Market's gross margins declined 50 basis points to 33.5%. The caused the company to close four stores, including three locations in Sacramento, CA. Considering the grocer's relatively young age and its plans to expand aggressively, closing stores is never a good sign.

Bottom line
The competition is heating up in the organic space, considering the growth of both public fresh grocers like The Fresh Market and Sprouts Farmers Market and private firms like Trader Joe's. Based on same-store sales growth and solid margins at Sprouts Farmers Market, the company continues to take market share from traditional grocers.

The company's future is bright, but its stock may continue to struggle in the short term. Typical of a high-growth concept, the story hasn't changed so much as the perception of value. The company will quickly grow into the current valuation with earnings surging over 40% annually.

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