Very few stocks put up positive returns in 2022. Sleepy grocery chain Sprouts Farmers Market (SFM 3.25%) was one of these companies, returning 9% for shareholders compared to a 19% loss for the S&P 500.
The company started last year at a discounted valuation, beat analyst expectations with comparable-store sales, and continues to repurchase stock from shareholders. With many bubble stocks down 50%, 80%, or more in 2022, shareholders of Sprouts Farmers Market were likely quite pleased with its performance last year.
But prospective investors don't care about prior returns; they care about the future. What's in store for Sprouts Farmers Market in 2023?
SFM Total Return Level data by YCharts.
Store expansion can drive earnings growth
Sprouts Farmers Market is a niche grocery chain focused on selling healthy food at a reasonable price. Essentially, its concept is similar to Whole Foods but for more price-sensitive shoppers, focusing on things like fresh produce, bulk goods, and items for specialty diets. The store started out in the U.S. Southwest but has since spread throughout California, Texas, and Florida. At the end of the third quarter, the company had 379 stores open in 23 states across the country.
Sprouts aims to grow its store count by more than 10% per year, an ambitious pace. With its stable unit economics since a new executive team came to the helm in 2019 (adjusted operating margin has been right around 6% for the last three years), this store expansion should be able to drive consistent earnings growth for Sprouts.
Since 2018, net income is up 41%, hitting $252 million over the last 12 months. In light of the company's long runway for growing store count, I would expect this net income number to be significantly higher three to five years from now.
SFM Net Income (TTM) data by YCharts.
Attractive valuation plus buybacks
What's great about Sprouts stock is that even though it's up almost 10% from a year ago, it's still cheap compared to the market average. At today's price, the stock has a trailing price-to-earnings ratio (P/E) of 13.5, which is well below the market average of 20. For a company whose net income is up 41% over the last five years, this looks attractive.
Management is taking advantage of this cheap valuation by plowing almost all of its free cash flow into making share repurchases, which reduces shares outstanding and increases earnings per share (EPS), one of the most important metrics for driving shareholder value over the long run. Since 2015, the number of Sprouts shares outstanding has fallen a whopping 36%. That's partly why EPS is up 75% over the last five years, outpacing net income growth. If these buybacks continue, it will be highly accretive to shareholders who hold for the long run.
SFM Net Income (TTM) data by YCharts.
So is the stock a buy today?
Our instinct as investors is to buy stocks only if their prices are falling, telling ourselves that they trade at a "discount" just because the price is lower. With Sprouts, it's important to get over this bias, because the stock still looks cheap today even though shares are higher than a year ago.
The company has a clear runway to grow, has consistent unit economics, trades at a discounted valuation, and has a management team set on returning cash to shareholders. What more could you ask for from a stock you're looking to hold for the long term?
