Grocery stores are a fairly steady but low-growth industry. Historical supermarket sales back this up, growing at a meager 0.5% annually from 2016 to 2021. This stat may keep growth-oriented investors away from the grocery space, but fear not, there is an under-the-radar opportunity within this market. Enter Sprouts Farmers Market (SFM 1.09%), a grocery stock that can give you both growth and value.
Image source: Getty Images.
What is Sprouts Farmers Market?
Sprouts Farmers Market (or just Sprouts) is a health-focused supermarket headquartered in Phoenix, Arizona. Most of its stores are located in California, the Southwest, Texas, and the Southeast. Sprout's value proposition is selling healthy and diet-specific food at a reasonable price. Its stores have a unique layout compared to traditional grocers with an open bulk and produce section at the heart of the store.
The company focuses on attracting what it calls "health enthusiasts" or people who follow specific diets like keto, plant-based, or gluten-free, with products catering to all of the popular diets. Management estimates that this limits Sprouts to only $200 billion of the $1.2 trillion in annual at-home food spend in the United States, but this is a sacrifice it is willing to make in order to differentiate the store experience from other grocers like Kroger and Wal-Mart.
Consistent growth and capital returns
With only 362 stores in 23 states at the end of 2020, Sprouts has tons of room for expansion. The company is opening up 20 stores this year, and from 2022 onward, management is guiding for annual store growth of 10% or more. It's currently making a big push in Florida where it just opened a new distribution center, and plans are to move up the East Coast with new stores over the next few years.
The consistent store additions have brought strong financial growth too. Net sales grew from $4.67 billion to $6.47 billion between 2017 and 2020. Beyond the top line, adjusted EBIT (earnings before interest and taxes) margin has started to expand over the last few years, growing from 5.7% in the first quarter of fiscal 2019 to 7.2% in the first quarter of 2021. Some of this margin boost was likely due to the COVID-19 pandemic lockdowns, which advantaged supermarkets over restaurants, so investors should track to see whether margins can stay at this level throughout 2021 and beyond.
One ding for this business was the fiscal first quarter's comparable sales, which were down 9.4% versus 2020. However, this was a tough comparison to an extra busy fiscal 2020 first quarter when panicked U.S. consumers were stocking up on food supplies at the start of the pandemic. Two-year comps were up 2.2%, a sign that existing Sprouts stores are still winning over customers.
Outside of consistent growth and profits, Sprout's management continues to return cash to shareholders through share buybacks. Over the last five years, shares outstanding have gone from over 150 million down to 118 million today. And on top of previous buybacks, the company just announced a new $300 million buyback program in March. With over $250 million in cash, a profitable business, and minimal debt, this gives Sprouts a prime opportunity to take advantage of this buyback program over the next few years.
Data source: Ycharts.
The valuation is cheap
Sprouts stock has a market cap of $3.29 billion as of this writing. The company is guiding for a range of $305 million to $325 million in adjusted EBIT (or operating income) this year. At the high end of that guidance, that would mean Sprouts trades at a forward price-to-operating-income (P/OI) ratio of just 10. This is cheap relative to most stocks on the market, especially when you consider Sprouts' plans for unit growth.
If you believe store growth can bring steady top- and bottom-line expansion while management continues to reduce share count through buybacks, the current share price of about $28 will look like a bargain a few years from now. It isn't a high-growth software company, but if you like growth stocks trading at a reasonable valuation, it might be smart to take a look at Sprouts Farmers Market.
