The grocery store industry isn't very exciting. It's dominated by mega-chains that have grown over the years through acquisitions, and they're all forced to compete with Walmart on price. That doesn't sound like a great place to find market-beating investments.
Loads of growth potential
One publicly traded grocery store chain does things differently. Sprouts Farmers Market (SFM 3.02%) purposely tries to be small. Its stores are a fraction of the size of a typical supermarket, and it makes no attempt to stock everything under the sun. Instead, it puts a large produce section with affordable prices front and center. The rest of the store is filled with a curated selection of products, 70% of which are attribute-based: vegan, organic, gluten-free, grass-fed, and so on.
Smaller stores are cheaper to build and can work in places where larger supermarkets would struggle. The company's new 23k sq. ft. store format costs $3.8 million on average to get up and running, brings in $13 million in sales, and reaches earnings before interest, taxes, depreciation, and amortization (EBITDA) profitability in the first year.
Sprouts operated 386 stores at the end of 2022, and it sees an opportunity to build 300 to 400 additional stores in California, Texas, Florida, and a handful of other states it views as expansion markets. The company aims to increase its store count by 10% annually starting in 2024, a task that will be made easier by its smaller store format.
On top of double-digit annual growth in store count, Sprouts is successfully navigating the current economic environment. The company reported its first-quarter results on May 1, and the numbers were generally impressive. Total sales were up 6% year over year, with comparable sales rising 3.1%. Adjusted earnings per share hit $0.98, up 24% from the prior-year period. Sprouts has done a good job managing inflation and keeping costs in check.
For the full year, Sprouts expects to produce sales growth between 5% and 6%, comparable sales growth between 2% and 3%, and adjusted earnings per share between $2.58 and $2.68. The company will open 30 new stores this year while closing 11, and the pace of store openings will quicken starting in 2024.
A hidden gem
If you've ever been to Sprouts, you know it's just a more pleasant experience than your run-of-the-mill grocery store. The company's limited selection can sometimes be annoying, but the pros outweigh the cons, at least in my book.
Many Sprouts shoppers seem to agree. The company has so far held on to its customers despite an uncertain economic environment, and it's maintained its margins despite inflation putting pressure on consumers. Sprouts may have more difficulty if the economy deteriorates further, but it's doing just fine so far.
Sprouts has the opportunity to double its store count, and even then, it wouldn't have a presence in many U.S. states. The company's current list of expansion markets excludes much of New England, the Midwest, and the Pacific Northwest.
Based on the high end of Sprout's 2023 earnings guidance, the stock currently trades for about 14 times earnings. Margins could contract if the economy takes a turn for the worse, but over the long run, Sprouts should be able to grow its earnings right alongside its store count. Share buybacks will also help -- the company spent $98 million on buybacks in the first quarter as part of a $600 million authorization.
Sprouts' strategy of building small stores with differentiated products is working. Investors who want to bet it will continue to work in the years ahead can buy Sprouts stock today for a reasonable price.
