On Sprouts Farmers Market's (NASDAQ:SFM) earnings conference call on Feb. 22, company management discussed a number of factors underlying a projected 2018 revenue increase of 11.5% to 12.5%, and expected comparable sales, or "comps" improvement of 2.5% to 3.5%. These are credible growth expectations within the hyper-competitive grocery industry, and as I discussed recently, they follow a surprisingly strong 2017 for the Phoenix-based natural and organic foods grocery chain.
Below, let's review three of the most significant growth drivers discussed on the call that should support Sprouts' expansion over the next 12 to 24 months.
Aggressive store opening pace
Sprouts' 2018 outlook calls for the opening of 30 new stores this year. This is slightly below the pace of last year's tally of 32 opened locations. However, the current target, which management has set as an annual minimum goal over the next few years, demonstrates that Sprouts is committed to aggressive growth, and it's crucial to the equation that allows Sprouts to hit annual revenue improvement between 10% and mid-teens percentages.
With a tiny footprint of just 290 locations, Sprouts isn't overly affected by the intensifying store-opening schedules of foreign-based rivals seeking U.S. expansion, particularly Lidl and Aldi, a phenomenon that's much more problematic for entrenched, ubiquitous chains like Kroger Co. (NYSE:KR).
During Sprouts' earnings call, CEO Amin Maredia noted that the company's development outlook for the next few years is quite robust, with 52 approved sites and 44 signed leases in the pipeline. And as it expands, Sprouts' modest size will allow it to slip into competitive regions without betting the farm. For example, Sprouts will enter the fiercely contested but lucrative Mid-Atlantic market in March with a single store opening in Maryland.
Incremental sales via delivery partners
In January, Sprouts announced a new partnership with privately held grocery delivery company Instacart, aimed at expanding the company's current delivery capability to each of its major markets, beginning with a phased roll-out in its home base state of Arizona.
Many of these markets are currently served under an existing partnership with Amazon.com's (NASDAQ:AMZN) Prime Now delivery service, although the long-term future of this relationship has been in doubt since Amazon acquired Sprouts competitor Whole Foods Market last year.
During the earnings call, management pointedly refused to comment on the current status of its Prime Now agreement, focusing instead on its potential moving forward with Instacart.
Regardless of which service the company ends up utilizing, shareholders should understand executives' perspective on the opportunity for delivery to add incremental sales, rather than simply provide convenience to current customers.
Since Sprouts' spacing between locations is much wider than conventional grocery stores, management believes that offering home delivery will widen the grocer's customer base. CEO Maredia explained the concept in detail in answer to an analyst's question on Feb. 22 and I've provided the entire answer below, as it's worth reading in full:
What we're learning is, for Sprouts, that the spacing between our stores helps us compared to the conventionals to capture incremental traffic in home delivery. So this is exciting for us because it fills in gaps naturally without opening stores through trade areas. And so because of that, we view this as an opportunity and not a cost burden that others may view it as. And generally what you see in the food business is most of your customers are coming to grocery shop within a seven-minute drive time. And so when you do home delivery outside of seven and ten minutes and go 15, 20 minutes out, you can capture incrementality, particularly if you don't have a store in that 10 to 15-minute drive time radius. So in markets where we have that gap, we're seeing good success.
In essence, the company may be able to extend the radius of a typical location's reach by anywhere from five to 10 miles using third-party delivery services, leveraging the infrastructure provided by each store, and thus supporting annual targeted double-digit revenue increases.
Keeping the tax savings powder dry
As a purely domestic company, Sprouts avoided having to record a one-time tax expense that many U.S.-based multinational corporations incurred on repatriable foreign earnings, under the Tax Cuts and Jobs Act enacted in December 2017. Instead, Sprouts was able to book a one-time non-cash tax benefit of $18.7 million.
Due to a lower effective tax rate resulting primarily from the tax legislation, management expects cash flow to increase by $30 million in 2018. The company plans to utilize one-third of this amount on wage and benefits increases for employees.
It's interesting that Sprouts isn't committing to how it will spend the remaining $20 million. Theoretically, the extra cash could be invested in any number of initiatives, from the company's burgeoning and profitable private label program, which grew 30% last year, to technology upgrades aimed at better labor management and the reduction of "shrink" (waste and slippage) in perishables inventory.
However, in response to analysts' questions, management acknowledged that it was leaving an option on the table to use its remaining tax savings of $20 million to invest in price to match competitors' promotions, if needed.
I believe Sprouts could similarly absorb a bit of projected 2018 cost inflation of 1% to 2% to reduce some of the price increases it might otherwise pass on to customers. For Sprouts, $20 million is a significant chunk of cash, representing one-tenth of last year's operating income, and 6.5% of operating cash flow.
Of course, competitors will also see lower effective tax rates. But Sprouts' lack of foreign exposure, lean operating profile, and higher margins versus conventional grocers will translate to more impact from its tax savings than its larger peers, which are also likely more inclined to pass on savings to shareholders through dividends and share repurchases. As we've seen throughout this discussion, being small is presently one of Sprouts' greater virtues.