Shareholders who only read the earnings headlines for the stocks they own are missing out: A ton of additional information can usually be gleaned from the related conference calls. For investors interested in the increasingly highly competitive fresh and organic market, Sprouts Farmer Market (NASDAQ:SFM)(NASDAQ:SFM)(NASDAQ:SFM) provided some solid numbers to digest during its recent third quarter.
The organic chain, mostly located in the Southwest, has ample opportunities for a regional to national expansion plan. The stock, however, faces short-term pressure from a significant stock sale from its largest shareholder, Apollo Global Management (NYSE:APO)(NYSE:APO)(NYSE:APO). Additionally, mounting pressure continues to build in an industry that is becoming overly competitive based on reduced guidance from organic leader Whole Foods Market (NASDAQ: WFM).
Only eight states
In addition to its fresh and healthy food trend, Sprouts offers a unique opportunity to invest in a growth concept in the regional phase. The typical retailer goes public with stores in at least 20 or more states. In this case, the company only has stores in Arizona, California, Colorado, New Mexico, Nevada, Oklahoma, Texas, and Utah. While the store count includes two of the larger states in California and Texas, it doesn't include any locations on the heavily populated East Coast, including states such as Florida and New York.
Whole Foods has 367 stores, with the long-term goal of reaching 1,000 stores in the U.S. The company has 94 leases in the development pipeline, and in the next couple of years expects to add additional stores greater than 50% of Sprouts' current store base. Sprouts' expansion plans might be hampered if Whole Foods continues to grow its store count at that rate.
Apollo stock sale of 22.5 million
On Nov. 7, Sprouts stated that Apollo would dispose of 22.5 million shares. Sprouts expects to report 150 million diluted shares for the fourth quarter, so the sale amounts to approximately 15% of the outstanding stock. At its current price of around $43, the proceeds to Apollo would be roughly $968 million. There's a likelihood that a discount will have to be offered to unload that large of a position. Such a move would place short-term pressure on Sprouts' price.
Apollo lists 54 million shares owned in Fund VI and would retain 40.4 million shares and a valuation of nearly $1.55 billion after the sale. One can hardly blame Apollo for cashing out a sizable position after a huge run following its 2011 investment in Sprouts at considerably lower prices. In the future, this large position by an external shareholder could place a ceiling on the stock, so the reduction in the ownership can be very positive for new investors.
Boulder store closed for 11 days
Bad retailers tend to find all kinds of excuses, including weather, to blame for weak quarterly results. In the case of Sprouts, the Boulder store was closed for 11 days due to flood damage, and this probably could have been longer if it were a weaker operator. The company did an excellent job of efficiently cleaning out inventory and repairing equipment. On top of that, it was able to save two-and-a-half truckloads of product and donate it to charity.
Despite this closure, Sprouts expanded margins by 130 basis points during the quarter. Conversely, Whole Foods saw a slight increase in margins, but the company lowered forecasts for its 2014 fiscal year. Unlike a bad retailer, Sprouts turned a negative into a positive with a large donation to charity and higher margins.
Sprouts continues to grow at an industry-leading pace, its two-year comparable sales are over 20%, and it has substantial expansion plans. The news of a significant sell by top shareholder Apollo will allow new investors the opportunity to buy the stock with less overhang from potential sells by the investment firm.
The sector, however, trades at extreme P/E ratios, with even Whole Foods garnering a 35 forward P/E after reducing estimates. On top of that, Sprouts trades at an incredible 78 times forward earnings, even though profits are only expected to expand 25% in 2014. While the company is worth following, long-term investors will have a hard time making money at these prices.
Fool contributor Mark Holder has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.