Sprouts Farmers Market Is Growing, but the Stock Isn't -- What Gives?

Sprouts Farmers Market (SFM -0.02%) has been holding its own in spite of what has become a crowded natural and organic grocery industry. Older grocery chains are updating their offerings, and Amazon entered the space last year, too, yet Sprouts continues to grow. But the stock does not. If the underdog continues to outperform, that could soon change.

Growing but not growing

Sprouts has been able to tap the rising consumer interest in healthier food. The grocer focuses on natural and organic products but with friendlier pricing than rival Whole Foods -- at least before it was an Amazon subsidiary. At any rate, Sprouts' strategy has paid off. At the end of 2014, there were 191 stores across 10 states. At last report, that number had ballooned to 285 stores in 15 states. The result has been strong business returns.

Data source: Sprouts Farmers Market quarterly earnings. Table by author. YoY = year-over-year. 

It hasn't only been new store openings, either. Same-store sales -- which combine foot traffic and customer bill size -- have also been increasing for years. Sprouts reported a 5.6% same-store sales increase over the last two years, 2.9% in 2017 alone. That's impressive, because grocery stores aren't exactly a new business. By comparison, Kroger, the largest grocer in the U.S., had a same-store sales increase of just 0.7% in 2017.

It may be surprising, then, that Sprouts stock has actually declined over 30% since 2014. Why? Investors may have been overly optimistic when the chain went public in late 2013. The company was valued at over 100 years' worth of profit at times, both from a price-to-earnings and price-to-free-cash-flow standpoint.

Data by YCharts. TTM = trailing 12 months.

Growth since then has been good but not that good. After the top and bottom lines rose -- and the share price declined -- Sprouts is still valued at 24 times trailing earnings. That's much more reasonable than a few years ago but still not cheap. However, if the company can maintain its momentum, things could be about to change for the stock.

Image source: Getty Images.

The Sprouts strategy

Sprouts Farmers Market is still a small grocery chain, so building new stores and expanding into new markets remains a priority. Management expects to open about 30 stores in 2018. Combined with an expected same-store sales increase in the low single digits, that should equate to revenue growth around 12%.

That isn't the top priority, though. The primary focus is growing private-label products, which have increased at least 30% in each of the last seven years. Private-label groceries, and the company's related expansion of in-store delis, are a way to increase profits and brand awareness. Despite the focus, the company's own products accounted for only 12% of sales last year, so there's plenty of room for improvement.

The last major initiative is simple: Keep pace with Amazon. A new website and app were launched a few months ago to help build out online shopping capabilities. Along with that, a new partnership was struck with delivery company Instacart, and home delivery is now in the works for every area Sprouts operates in. New product management and supply chain technology will also roll out in 2018 with the goal of making the business more efficient. Management said new announcements around technology will be forthcoming throughout the year.

Sprouts' progress hasn't rewarded investors the last few years, but that could change. The stock isn't a bargain, but it looks like a fair value if the company can deliver on its growth initiatives. There's a good chance that will happen, as Sprouts has expanded quietly in the face of significant competition and has a plan to keep the good times rolling.