sprouts farmers market business model

The company is changing its messaging to focus on how its produce differs from that available at other stores, its prices are lower than those of competitors, and it offers more varieties of local organic foods, Sinclair said. Store traffic increased each month during the third quarter, he added, and the team continues to test new messages.

Q3 financials

For the third quarter, Sprouts reported its financial results with comparisons to both fiscal 2020 and fiscal 2019:

• Net sales of $1.5 billion were a 4% decrease from the same period in 2020 and a 5% increase from the same period in 2019.
• Gross profit for the third quarter of fiscal 2021 was $540 million, a 7.7% decrease from the third quarter of fiscal 2020.
• Gross profit margin was 35.8%, a decrease of 131 basis points, or 1.31%, from the same period in 2020. The margin was 265 basis points, or 2.65% higher, than the margin from the same period of 2019.
• Net income of $64 million compared with net income of $60 million and adjusted net income of $62 million in Q3 2020. The adjustment, a calendar shift because 2020 had 53 weeks, was made to align holidays in the two years.
• The $64 million net income also was compared with net income of $26 million from Q3 2019.
• Diluted earnings per share of $0.56, compared to $0.51 diluted EPS and adjusted diluted EPS of $0.52 in 2020. Diluted EPS for Q3 2019 was $0.22.

Sprouts also released financial results for the first three quarters of the year, compared with the same period for 2020:

• Net sales total $4.6 billion, a 5.6% decrease from $4.87 billion in 2020.
• Gross profit was $1.7 billion, a 6.9% decrease from $1.8 billion in 2020.
• Net income was $207.9 million, a 5.4% decrease from $219.1 million in 2020.

New CFO expresses optimism

Chip Molloy, a former Sprouts board member, was appointed chief financial officer effective Sept. 25, after Denise Paulonis left to become the CEO of Sally Beauty Holdings Inc. During the earnings call, he addressed his reasons for joining the executive suite.

"First and foremost, I love this company, its people and its purpose of providing healthy living options at reasonable prices," said Molloy (left). "Second, the stage has been set for future success. We have a differentiated customer experience with unique product offerings, and a new prototype that should allow us to aggressively expand our reach while creating shareholder value along the way.

"As we continue to learn more about those customers that love us and tell that message to those that don't know us, we will slowly but surely turn the corner on comp-store sales while still maintaining relatively stable margins," he continued.

Although Molloy said it was too soon to offer definitive expectations for 2022, he said Sprouts plans to open 25 to 30 new stores — a strong pipeline of leases and sites already exists — mostly likely during the fourth quarter. COVID-19 is affecting supply chains, as well as municipal improvements and developments. The retailer currently operates 362 stores in 23 states.

This article originally appeared on  New Hope Network , a Supermarket News sister website.

More information about text formats

• Allowed HTML tags: <em> <strong> <blockquote> <br> <p>
• No HTML tags allowed.
• Web page addresses and e-mail addresses turn into links automatically.
• Lines and paragraphs break automatically.

More From Forbes

Sprouts farmers market is improving profits and creating shareholder value.

• Share to Facebook
• Share to Twitter
• Share to Linkedin

Low-angle view of sign for Sprout's Farmers Market, a health food grocery chain on a sunny day in ... [+] Dublin, California, September 7, 2018. (Photo by Smith Collection/Gado/Getty Images)

Despite missing top-line estimates in 3Q21 and giving back some of the pandemic-induced sales of 2020, this company is more profitable than it was pre-pandemic and is expanding its reach in the fast-growing health and wellness and natural/organic grocery markets. Sprouts Farmer’s Market (SFM) remains a Long Idea.

Sprouts Farmers Market Has Very Attractive Risk/Reward

I made Sprouts a Long Idea in  November 2020 , and the stock has underperformed the market by 10% since then. However, given the company’s strong market position and cheap valuation, I continue to see upside in the stock.

Figure 1: Long Idea Performance: From Date of Publication Through 11/9/21

Long Idea Performance: From Date of Publication Through 11/9/21

What’s Working:

Sales Remain Up from 2019 and Shoppers Are Spending More.  Sprouts Farmer’s Market beat bottom-line expectations, despite missing top-line estimates, as sales slowed from record levels seen in the prior year period when grocery sales soared amidst lockdown orders and rising COVID-19 cases. Despite falling from 2020 highs though, 3Q21 revenue is still up 5% over 3Q19.

Compared to 2019, Sprouts notes that customers are buying more products per purchase and paying higher average prices via “a combination of mix, fewer promotions, and inflation.”

Going forward, management expects sales to grow “in the low- to mid-single digits” year-over-year (YoY) in 2022.

Best Tax Software Of 2022

Best tax software for the self-employed of 2022, income tax calculator: estimate your taxes.

Margins Remain 2 nd  Only to Amazon.  Other grocers with more commoditized offerings may struggle to maintain margins as inflation rises. However, Sprouts notes that outside of certain protein products, it has been “able to pass on what’s been passed on to us”, which is why net operating profit after-tax (NOPAT) margins of 5.5% over the trailing twelve months (TTM) remain higher than any year of my firm’s model.

Additionally, Sprouts’ focus on local sourcing means the company has a powerful negotiating position over much smaller suppliers to which Sprouts is a “big customer.” Per Figure 2, Sprouts’ NOPAT margin ranks above all competition except for Amazon (AMZN), whose margin undoubtedly gets a boost from its software/cloud business.

Figure 2: Sprouts’ NOPAT Margin Vs. Competition

Sprouts' NOPAT Margin Vs. Competition

New Store Format Helps Maintain Margin Improvement.  Any further increase to the cost of its products can also be mitigated with the roll out of Sprouts’ updated store format. The new stores aim to tap into the “farmer’s market” experience Sprouts is known for and expand frozen and refrigerated offerings.

The new stores cost on average 20% less to build largely due to 50% lower cost in deli fixtures and 50% lower cost in protein fixtures. Additionally, Sprouts estimates the smaller stores cost on average 20% less to operate due to lower rent and reduced labor costs from the addition of self-checkout.

Most importantly, despite being smaller in size, the more efficient layout means Sprouts is not reducing the number of products sold, and management expects “sales to be at least equal to the larger boxes we built in the past.”

Store Growth Increases Market Reach.  Sprouts Farmers Market has improved profitability while continually expanding its store count. From 2013 through the end of 3Q21, Sprouts has grown its store count 10% compounded annually. The firm plans to open nine new stores in 4Q21 and another 25-30 stores in 2022. Increasing its return on invested capital (ROIC) (from 7% in 2013 to 12% TTM) while also growing its store count at a high rate is no small feat. Very few companies are able to achieve growth and improve ROIC at the same time.

Private Label Also Aids Profitability.  Sprouts’ private label business helps differentiate it from the larger box retailers, while boosting profitability. The company notes its private label products also provide customers with “lower prices while still delivering generally higher margin as compared to branded products.” Sprouts’ private label products as a percent of revenue have grown from 10% in 2016 to 16% in 2020.

Ecommerce Gains Have Persisted.  In 3Q21, ecommerce sales made up 10% of revenue, which is up slightly from 9.5% in 2020 and just 3.7% in 1Q20 (the earliest available data). Ecommerce sales correlate to higher spending per consumer, as Sprouts noted in its  2Q21 earnings call  that “the e-commerce basket remained significantly higher than an in-store basket.”

Going forward, Sprouts’ ecommerce sales provide growth opportunities. The company notes that between Instacart and its own site, it is “collecting customer data on ~2/3rds of those who shop online”, which can then be leveraged to support additional online and brick-and-mortar sales.

Positioned in Fast-Growing Markets.  The demand for health and wellness products, along with natural and organic products, is growing at a rapid pace that provides Sprouts a long-term runway for growth.

• The global organic food and beverages market is  expected  to grow 16.4% compounded annually from 2020-2028
• The global health and wellness products market is  projected  to grow 6.3% compounded annually from 2021-2025

What’s Not Working:

After record-breaking sales in 2020, Sprouts’ comparable store sales growth is negative YoY through the first nine months of 2021. However, TTM sales remain higher than any annual period prior to 2020, and sales through the first nine months of 2021 are up 8% over the same period in 2019. In other words, while the company has given back some of the revenue gains of 2020, sales still remain higher than pre-pandemic levels.

Sprouts’ previous marketing, by admission of its management team, failed to effectively communicate its competitive and/or lower prices to consumers. The value proposition wasn’t clear until consumers reached the store, which helped drive Sprouts’ market share, as measured as revenue as a percent of  U.S. grocery store sales  down from 0.84% in 2020 to 0.79% over the TTM. However, even with this decline, its average market share over the past three years remains at 0.81%, which is up from 0.77% in 2019 and 0.41% in 2014.

To address its ineffective marketing, Sprouts updated its materials to highlight pricing and differentiated products such as local varieties of organic produce. Store traffic improved in each month of 3Q21, and management believes the updated marketing materials are an important factor in that improvement.

While Sprouts has been able to pass on most cost increases, ongoing labor shortages across the country still impact the company. In 3Q21, Sprouts experienced lower job applications, and should available labor tighten, margins could be at risk.

SFM Is Still Priced for Permanent Profit Decline of 60%

Despite a growing market, a more profitable business operation, and expectations for a return to YoY growth in 2022, SFM still trades below its three-year average economic book value (EBV)[1]. With price-to-three-year-average economic book value ratio of 0.4, the market is expecting significant profit decline, despite management guidance and consensus estimates for the opposite.

Below, I use my firm’s reverse DCF model to analyze the expectations for future growth in cash flows baked into a couple of stock price scenarios for Sprouts.

In the first scenario, I assume Sprouts’:

• NOPAT margin falls to 4% (company low in 2016, compared to 5.5% TTM and 5-yr avg of 4.5%) from 2021 through 2030, and
• revenue falls 6% compounded annually through 2030

In this scenario, Sprouts NOPAT falls by 9% compounded annually over the next decade and the stock is worth $25/share today – nearly equal to the current price.  See the math behind this reverse DCF scenario . For reference, Sprouts grew NOPAT by 9% compounded annually from 2014-2019.

Shares Could Reach $63 or Higher:  If I assume Sprouts’:

• NOPAT margin falls to 4.5% (5-year avg) and
• revenue falls 6% (equal to consensus estimates) in 2021, and
• revenue grows 2% a year each year thereafter through 2030 (below consensus estimate for 6% in 2022 and 8% in 2023), then

the stock is worth $63/share today – 133% above the current price.  See the math behind this reverse DCF scenario .

Should Sprouts maintain current margins, or grow revenue even faster than assumed above, the stock has even more upside.

Figure 3: Sprouts’ Historical and Implied NOPAT: DCF Valuation Scenarios[2]

Sprouts’ Historical and Implied NOPAT: DCF Valuation Scenarios

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.

[1] I calculated Sprouts’ economic book value using a 5-year average WACC of 3.5% to normalize the impact of significantly lower WACC in 2020 and the TTM period.

[2] I use the override capabilities in my firm’s DCF model to replace Sprouts’ TTM WACC (2.5%) with its 5-year average WACC (3.5%) in both scenarios.

• Editorial Standards
• Reprints & Permissions

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

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources , and more. Learn More

NASDAQ: SFM

Sprouts farmers market.

The company is an underappreciated retailer.

Shares of Sprouts Farmers Market ( SFM -2.01% ) 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 .

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.

Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

Stocks Mentioned

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Our Most Popular Articles

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.

Smaller size serves Sprouts well

PHOENIX — Several years ago executives at Sprouts Farmers Market, Inc. made the decision to shift from building larger format stores to smaller store models with more thought put into the positioning of departments. The strategy has paid off as the retailer is turning out some of its best volumes in years.

In a March 10 presentation at the virtual UBS Global Consumer and Retail Conference, Jack L. Sinclair, chief executive officer of Sprouts, highlighted some of the biggest differences between the old store model versus the new store model.

In terms of space, Sprouts has cut back on the size of its stores, to 23,000 square feet from 32,000 square feet. Mr. Sinclair said a lot of the space that has been eliminated was previously backend space and not consumer-facing space. The company has redesigned the dairy prep area, the meat prep area and the bakery prep area, moves that have allowed the retailer to hold onto most of its stock-keeping unit count.

“(This) gives us some confidence that we can hold the sales,” Mr. Sinclair said.

He said Sprouts has “doubled down on frozen foods,” creating a lot more space for frozen.

“Frozen not that long ago was the kind of ugly stepchild of the grocery industry where people, kind of, thought, oh, it's all the bad stuff that goes in there,” he said. “We've kind of turned that on its head. And I would say 90% of what we sell, you won’t find in an Albertsons or a Kroger or somewhere like that. And we're seeing real success in the product innovation and development in frozen. And that’s something we’d like to find a way of doubling down on our existing store base. It's expensive, but we're looking at finding ways of doing that.”

The retailer also has changed the positioning of its meat department, Mr. Sinclair said, moving meat and plant-based products to the front of the store, in front of deli.

“We've flipped meat and deli,” he said. “We've significantly changed the investment in deli equipment and decor and the whole way it feels and looks. And it looked really good in the 32,000 square feet, but it cost $140,000 to put a big thing above the deli. So we cut back on a lot of things that we thought were actually not helping the consumer.”

Another change has been the move of the bakery department from the front of the store to the back.

Related Articles

Sprouts modifying store size, format, new smaller perfect bar unlocks ‘sizeable opportunity’, for pepsico, size matters, slideshow: bite-size innovation blowing up in 2020, sprouts sees strong demand for private label, featured webinars, food entrepreneur experience — the future of functional, current issues.

Popular Articles

Technical bounce keeps on lifting soybeans, mondelez has big plans for acquired brands, nestle sees tough choices ahead, winning big with snack innovation, popular galleries.

New on the shelves

Spring-time offerings bring limited-edition partnerships.

Sweet treats join shelves in new formulations and collaborations.

Search Winsight Grocery Business

Krasdale’s Bravo Supermarket boosts Florida footprint with new store openings in Ocala and Sarasota

Costco’s sales growth tapers off in second quarter, hannaford acquires independent grocer tradewinds marketplace in blue hill, maine.

• Grocery Outlet opens new store in California
• HMart to open 2nd store in Austin

Sprouts Makes ‘Progress’ in Transforming Its Stores

Sprouts Farmers Market is on a mission to regain its status as a destination.

The Phoenix-based grocer lost transactions earlier in the pandemic when consumers made fewer shopping trips—an unwelcome trend exacerbated by a shift away from its once-aggressive promotional pricing that further eroded traffic. But with sales gains made in the third quarter of 2021, Sprouts executives say they’re confident the company's stores are on the right track.

For the 13-week third quarter ended Oct. 3, 2021, Sprouts reported net sales of $1.5 billion — a 4% decrease from the same period in 2020 and a 5% increase from the same period in 2019. The sales decrease was due primarily to a decrease of 5.4% in comparable-store sales growth, according to the company. Two-year comparable-store sales growth also declined 2.1%. While the sales dip wasn’t the tumble that the Phoenix, Ariz.-based grocer took in the second quarter of 2021—which saw net sales down 7% and comparable store sales down 10%—there’s still “work to be done,” said CEO Jack Sinclair.

Sprouts net income for the third quarter of 2021 was $64 million; compared to net income of $60 million and adjusted net income of $62 million in the same period in 2020 and compared to net income of $26 million from the same period in 2019.

“Our third quarter sequential improvement in sales and robust profits, combined with the early performance of our two newly designed stores, give us confidence we are making progress in transforming Sprouts—built on the longstanding foundation of a farmers market heritage,” said Sinclair in a statement. “Moving forward, while there is work to be done, we are supported by a robust unit growth story, passionate team members, a loyal customer base, and our fresh differentiation, providing the ingredients for long-term success as a specialty store destination.”

In its recent third-quarter earnings call, Sinclair’s optimism about the company’s future was tempered by the acknowledgement that Sprouts has at times missed the mark on consumer messaging, especially when it comes to its produce offerings and pricing.

“We have the right strategy and are excited about moving it forward piece by piece, making great progress on our supply-chain-differentiated merchandise, new format and-real estate selections," Sinclair said during the earnings call, according to a Sentieo transcript. "However, our initial marketing messages fell short.” He added: “We fully expected to see a positive two-year stack in the back half of this year, and through the third quarter, we did not. With this in mind, we’re focused on delivering a clear message that highlights our sharp produce pricing, innovative products and a farmers-market experience to drive additional transactions in the quarters and years ahead.”

It’s been an uphill battle for Sprouts to bounce back from both the impact of COVID and pulling the plug on “ineffective and unprofitable” promotions, admitted Sinclair, who added that in the second quarter of 2020, Sprouts lost approximately 25% of its transactions. “To date, they have not returned,” he said. Additionally, the change to its promotional approach resulted in a loss of coupon clippers.

“What is encouraging is that those pre-pandemic customers that make up to 75% of transactions—that stuck with us—are putting more units in their basket today than they did in 2019, paying higher average prices via a combination of mix, fewer promotions and inflation, resulting in record third quarter profits. Our sales in the third quarter of this year were up 5%, and our earnings per share was up 155% when compared to the same period in 2019,” he continued.

Sprouts continues to refine its brand and marketing approach with “everyday great pricing and unique product offerings,” said Sinclair, adding that an updated store prototype—one with a differentiated product selection in a smaller, yet more efficient store—has resulted in higher financial returns and the ability to grow faster in new markets, thereby building density and brand awareness.

In terms of assortment, vitamins, deli, grocery and back-to-school offerings were key sales highlights for Sprouts in the third quarter. New on-trend, own-brand products also keep “the innovation train moving,” said the CEO. In the third quarter, Sprouts also reset its wine departments to feature more than 50 new selections focused on transparency and sustainability.

“The wines along with the other unique products mentioned are driving home the best part of a farmers market—exploring new and exciting products from people and companies with interesting stories and passions,” he said.

The innovation, product additions and a renewed emphasis on competitive pricing in produce are all part of Sprouts’ strategy to add profitable sales growth, get more customers in the door and create more loyalty with its target customers.

“Earlier this year, we fell short in communicating our commitment to great prices in our marketing, especially in produce,” said Sinclair. “While it was present in-store, we didn’t effectively communicate our value message to our customers. We began to address this imbalance in the third quarter by trying new things. Some worked, some didn’t.”

What worked were special events focused on its differentiation in the produce category (more local and new varieties and organic products), as well as actively promoting its competitive pricing.

"Throughout the third quarter, our traffic slightly improved each month, as we believe our customers responded to these new messages," said Sinclair.

"During the fourth quarter, we are continuing many of these tests on a broader scale. And we’re doing more mass media on Sprouts' strengths like promoting compelling, high-perceived value items that are more relevant to our core customer," he said. "As well, we continue to refine our broader brand message and campaign to attract those new customers still unaware of Sprouts’ differentiated store."

On the expansion front, Sprouts noted that because of supply-chain delays, approximately six new stores previously planned to open in the final quarter of 2021 could be delayed until 2022. The company further said it expects to open nine new stores in the fourth quarter of 2021 for a total of 14 new stores and one relocation this year.

Want breaking news at your fingertips?

Get today’s need-to-know grocery industry intelligence. Sign up to receive texts from Winsight Grocery Business .

The latest from Winsight Grocery Business , sent straight to your inbox.