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Why Sprouts Farmers Market Can Be a Great Long-Term Holding

By Brett Schafer - Jan 18, 2021 at 8:00AM

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The company is an underappreciated retailer.

Shares of Sprouts Farmers Market (SFM 2.27%) have struggled over the past five years. The stock trades at about $21 per share as of this writing, and investors are still underwater from highs reached in 2016 when shares hit $30. The company isn't a household name in grocery and is underfollowed on Wall Street. However, with a revised business plan that was put in place by a new, experienced management team, it looks like Sprouts has gotten its mojo back.

Here are a few reasons why investors should look to add shares of Sprouts Farmers market to their portfolios.

Two people chopping fresh produce.

Image source: Getty Images.

The business model

Sprouts is a grocery chain with a focus on natural foods that are also affordable. This combination has been its main selling point to customers since it opened its first store back in 2002.

The heart of a Sprouts store is an open layout of fresh produce, which is supposed to replicate the feel of a farmer's market. Stores also have a huge vitamin and supplements department. All-in-all, Sprouts seems to be targeting health-focused consumers who don't want to break the bank shopping at competitors like Whole Foods. 

At first glance, it seems strange that Sprouts stock has gone sideways. It grew overall sales every year from fiscal 2015 through 2019, from $3.59 billion to $5.63 billion. However, net income stagnated during that same period with declines in two of the last four years. The fiscal 2019 result of $149.6 million represented a 5.6% decline from the prior year. Adding to the uncertainty was the sudden resignation of CEO Amin Maredia at the end of 2018.

The company brought on Jack Sinclair to replace Maredia in June 2019. Sinclair has 35 years of experience in the retail and grocery industry and was the vice president of U.S. grocery for Walmart from 2007 to 2015. Since he was hired, Sinclair has built up his new executive team, hiring a new chief financial officer, chief marketing officer, and chief merchandising officer (an especially important role at a grocer).

The new management team has stated that it wants to continue Sprout's track record of consistent sales growth but has revised part of its strategy when it comes to increasing profitability. On the marketing front, Sprout's has stopped mailing newspaper ads, focusing its spending on television and digital marketing. It has also experimented with different store formats, shrinking some new locations from the traditional 30,000 square-foot layout to between 21,000 and 25,000 square feet, which reduces start-up costs without affecting affect per-store sales.

Lastly, the company is planning to open new distribution centers so the majority of its stores are within 250 miles of one. Not only should this help with freshness and customer satisfaction, but it also should improve profit margins over time as Sprouts works to vertically integrate its supply chain.

A look back at 2020

As a grocery chain, Sprouts encountered minimal restrictions during the pandemic. This no doubt provided the business with a tailwind as many other food establishments struggled to stay open in 2020. Revenue was up 9.5% last quarter with comparable-store sales growth of 4.2%. Gross profit was up 23% to $585 million, and through the first nine months of fiscal 2020, Sprouts generated $410.3 million in operating cash flow.

Generating cash is important for the company, because it allows Sprouts to finance its growth from existing operations instead of taking on more debt or diluting shareholders through stock offerings. The company plans to grow its store count by 10% annually, and it looks like it has a long runway to increase that count as it only had 356 stores in 23 states as of Sept. 2020.

Sprouts Farmers Market currently has a market cap of $2.47 billion, giving it a trailing price-to-earnings (P/E) ratio of less than 10. Given the fact that Sprouts has a relatively clean balance sheet (only $285.7 million in long-term debt), is generating plenty of cash, and has a long runway to reinvest and grow its store count over the next decade, it currently looks like a quality retailer trading at a dirt cheap price. If new management can build off the 2020 momentum, shareholders should be rewarded long term.

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Stocks Mentioned

Sprouts Farmers Market, Inc. Stock Quote
Sprouts Farmers Market, Inc.
$25.74 (2.27%) $0.57
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
$123.72 (0.08%) $0.10

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