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Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

Sprouts Farmers Market Healthy Grocery

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

I recently read this quote at the bottom of a photo on a social network. Without realizing it, I was reading what had been my way of making decisions in recent years. I have learned that, both in my personal life and in the world of banking and investment, one must remember their mistake along with everything that led one to make those same decisions.

Without a doubt, those decisions and those mistakes are what have made us get to where we are. When it comes to investing, I always follow the same philosophy, which is neither more nor less, than reasoning each decision I make. In this way, whenever I make a mistake, I will know perfectly what the reason is and everything that has led me to that point, and I will know what I must correct or what I must change.

This same method has led me to be here today writing these lines. Today, as my first publication, I would like to retrieve the last one I made in the forum, which I hope will be the first of many. In some way, I hope that while I share my knowledge with each person who reads it, it will serve me as a learning and evolution and a compilation of my progression in this world of investment and analysis.

Next, I proceed to comment on one of my latest investment ideas:

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

Sprouts Farmers Market (SFM)

Current price  ($20.85) 

Indeed on any given day shopping at Carrefour, you will have passed through the new ECO section, where many products with organic and ecological denominations are sold. You will surely have noticed how this section has grown in size with time, along with the number of people who buy products from it. Well, this is precisely the niche where #SFM sells.

This company was founded in 2002 as a retail seller of fresh, natural and organic products. That is to say, products with little or no processing have not suffered any alteration in their production at the genetic, hormonal, chemical treatment level and that also do not contain preservatives or additives. We could pigeonhole it into the type of diet followed by vegetarian, vegan, “Realfooder,” detox people… which is so fashionable.

And this is where this idea comes from, since nowadays, the growing number of people who join this type of trend or seek a healthier diet does not go unnoticed. With the rise of fitness and personal or physical care, this market has experienced a significant expansion, becoming today the fastest-growing segment of the retail food market. 

In 2018, the number of sales of organic and natural products in the US increased by 6.9% to 219B, while sales of food and conventional products have decreased by 0.2% that same year, according to a market study carried out by “New Hope Network,” a leader in studies on this type of market segment.

Illustration 1: Graph obtained from the study carried out by “New 

If the projection were observed in 2021, this number of sales would exceed 250 Billion, which implies not only that it is a fashion market, but also that it is expanding; or what is the same, the cake is getting bigger, and therefore,

 if you have a piece of the cake, organically and in step with the market, your number of sales will be increased by the mere fact of belonging to that segment

SFM currently has  350 stores in leased premises in the US alone, opening around an average of 30 new stores a year. In turn, it segments its sales into two parts: 

– Persistent  (represents  58% of sales ), which includes foods such as fruits and vegetables, meat, fish, shellfish, confectionery, floral 

Non-Persistent  ( 42% of sales ) includes vitamins, supplements, frozen foods, beers, wines, and natural body care products. 

Of the products it offers, around  14% belong to its brand, which implies an offer of more than 3,000 own products and tries to distinguish itself from the competition in superior quality. 

The food market in the US covers around 1.2T dollars in sales, of which approximately 200B corresponds to this specific segment. Of that 200 B in sales, Sprouts Farmers Market accounts for only  5B in sales. Which means a wide field of market share to capture and grow. With a large amount of market share that it can charge, it is worth considering that, in the words of the company’s current CEO 

“an increase in 3% of market share would imply doubling the number of sales”.

Illustration 2: Graph obtained from the company’s presentation on the strategy for 2020

The competition would be formed mainly by conventional supermarkets such as Kroger, Albertsons and Safeway. Also, similar stores like Whole Foods (Amazon), Natural Grocers by Vitamin Cottage or Traders Joe’s. E-commerce such as Amazon would also enter the competition, although we can always put the latter in competition in any business lately. 

Sprouts’ primary strategy for gaining market share is to capture customers who buy these products in conventional supermarkets by providing higher quality products, specific and concrete advice, and its brands. Or at least today, its leading market share capture has been this. 

We must not forget that not all of the market share is held by conventional supermarkets since as the sector grows, the number of customers increases.

To explain it in a simplified way, and by way of example, that a person usually buys at Mercadona does not mean that all their purchases are centred in the same establishment; since it may be the case that you prefer to buy the meat in the local food market.

 In this case, just because a person purchases Walmart, it does not mean that they will buy organic or ecological products here. It is not about stealing customers but about exploiting a growing market niche by providing something more than conventional markets offer.

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022
Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

We could specify that its main advantage over supermarkets and e-commerce would be, on the one hand, an offer of quality products that are different from those of the competition, while on the other, 

the closest advice or treatment of the staff in the subject of the incredible variety of products and their specific characteristics, especially for the number of new people who are entering this world. 

The latter might seem silly if it weren’t for the effectiveness it has brought about in other sectors such as the “auto parts” market; It has already been seen that in the case of companies such as Autozone (#AZO) or O’Reilly (#ORLY) this advantage,

 which involves training staff to advise the client, has been the main asset of competing with the e-commerce and the mighty Amazon. So, despite the latter’s attempts to enter the auto parts sector, market penetration has been unsatisfactory since, despite offering a cheaper product, the customer needs advice from a specialist when choosing a specific part of the car. 

Extrapolating this to the topic that concerns us, we could see how many people entering the organic segment need advice when choosing products and what each one entails. What’s more, we should bear in mind that people who enter this type of market niche are explicitly looking for a healthy, little processed and natural product. Therefore, they will look for specialized personnel who will recommend how to start and what products to use, generating loyalty towards the store at the same time. 

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

A more similar example of this could be seen in the sale of sports supplements, whereas as a result of the boom in recent years, it has begun to be marketed in supermarkets. However, the average customer prefers to buy from specialized stores, as they offer excellent advice and a sense of trust, despite being the same products and brands. In the case of #SMF, it should be noted that it also has its brand.

In the middle of 2019,  the company was immersed in an extensive remodelling from the corporate point of view, with the replacement of numerous directors, including the CEO, the Chairman and the CFO. With this replacement, there has been a change of course for the company which, in my view, gives the business a new twist that it needed. 

With this change at the helm, a new roadmap for 2020 and subsequent years was presented in Q2 2019. In this new roadmap, points such as are defined. The progressive increase in gross margin on sales through a reduction in the average kilometres of distribution (going from more than 500 kilometres on average to practically half) through the opening of two new distribution centers  (going from 5 to 7 DC’s). 

The reduction of the size of the stores  

(Box) in such a way that a double objective is achieved; that people have a more rewarding experience when shopping by having everything more at hand and spending less time in the store while reducing the cost of surface area used both in renting and in transforming the premises, 

In addition, a series of improvements have been implemented, which broadly represent an increase in the margin thanks to an improvement in the efficiency of inventory management. 

On the other hand, and finally, a drastic change in the marketing and promotion policy, the company has chosen to end outdated paper promotions and discount coupons; and has opted for an online expansion in networks and digital advertisements. 

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

With this, it has suddenly eliminated price competition through discount coupons that only produce customers loyal to the price and reduce sales margins by offering a lower price. It focuses advertising both on networks, online ads and TV. to differentiate your product from the rest.

This change has not meant an extra investment since savings in paper and coupons have been mainly the source of spending on the new type of marketing and advertising. With COVID, the company took advantage of the withdrawal of the distribution of advertising to homes to implement this digital marketing, which would be done gradually.

The result has been satisfactory since there has been no reduction in the influence of people, what is more, it has increased. While the competition after the end of the first wave of the virus returned to sending discount coupons and advertising on paper, Sprouts, with its new strategy, has managed to outperform the more direct competition without sending coupons and advertising to homes again. 

Turning to an economic-financial analysis: 

From the point of view of solvency, this company is in a pretty good position; its indebtedness at the end of 2019 only meant multiplying EBITDA by 1.3. Let’s take into account its excellent behaviour during the pandemic. 

We can see that currently, and with the accumulation of excess cash that it has suffered, this ratio has dropped to 0.3 times EBITDA. In other words, an almost zero debt position makes for a solid balance sheet and a point in its favour.

If we look at liquidity, we can see how it has no short-term debt and manages to finance most of its assets in the short term through spontaneous financing (suppliers) that does not entail any cost. Your working capital is harmful because of the latter. 

In addition, it has been carrying out an aggressive repurchase of shares for four consecutive years, which sheds light on the cash generation of this company. 

For the valuation 

of the company, which has been growing around 13% in sales annually for the last three years; being conservative, despite its new policies, change of course and without taking into account the growing trend of this market niche in general, which in my opinion will represent a considerable increase. Assigning a conservative growth of 7% per year in sales (which I have already mentioned in the annual growth rate of the market segment), applying an EBIT margin of 4%, which is the average of the last two years, although with the new implementations this percentage is expected to increase. Along with a tax rate of around 23%. 

And applying a valuation PER of 12 times, which is below the market average of small grocery stores excluding supermarkets (the market average is around 14 times PER), we obtain a 5-year valuation with a CAGR of 5% per PER which does not seem so attractive. However, we must remember that this is a pessimistic scenario (growth in sales much lower than in the last six years, margin lower than in the previous eight years).

But if we apply an EV/EBITDA valuation of 11, which would not be unreasonable (it is its average valuation since its IPO), we obtain a three-year CAGR of 18% at five years. Not bad, considering how conservative we’ve been. I have to say that the repurchase of shares that I have applied to the model is below, not average, 

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022
Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

Sprouts Farmers Market Healthy Grocery, Organic Food Investment idea 2022

We are being more realistic, seeing how the chain has behaved during the Covid—assigning an annual growth of 9%, without reaching that 10% set by the company’s CFO as a goal for successive years, and an EBIT margin of 5%, taking into account the measures taken to increase the gross margin on sales mentioned.

We get that at a multiple of 12 times earnings (remember the market is priced on average at P/E 14, so we are pricing it at a discount of 15% below market), the CAGR per P/E would be 12%. In contrast, by EV/EBITDA, applying the exact previous multiple of 11 gives a CAGR of 24%.

Finally, suppose we put ourselves in an optimistic scenario, with 10% annual growth in sales, which is the company’s objective announced in its strategic guide in 2019. In that case, it manages to experience the push it is looking for, thanks to the new market share capture. 

And an EBIT margin of 6% due to the new inventory management and distribution policies, we would put ourselves at a CARG per 5-year PER of 28% or a CARG per EV/EBITDA of 29%.

Which seem like quite attractive results

I want to conclude, as a great admirer of Peter Lynch, contributing my vision as belonging to the “Millennial” generation that I am. My impression is that both in my age, and those to come (generation Z), the fashion for healthy, organic, natural, fitness food, or whatever we want to call it, is stronger than ever. The general trend is to seek, and increasingly, healthy products, the less processed, the better and organic.

With the rise of “influencers,” both on YouTube and social networks, such as Instagram, this type of feed is the projected main image, which is creating a habit. You have to go through the main accounts with the most followers on Instagram to see this type of content.

But you don’t have to go online to see this; I look at friends, acquaintances or colleagues to see how this trend is becoming more widespread. Therefore, and as a conclusion, I would dare to assure you, together with the market studies and the movement during this year 2020 and the Covid, that this segment has a long way to go and expand, becoming dominant in the food sector.

Frequently Asked Questions: Sprouts

Is Sprouts owned by Whole Foods?

Is Sprouts owned by Whole Foods? No is the short answer. The first Sprouts Farmers Market was opened in 2002 by Stan and Shon Boney in Chandler, Arizona. They are still a privately owned Arizona-based chain with locations in Arizona, California, Colorado, and Texas.

Is Trader Joe’s cheaper than Sprouts?

Yes, Trader Joe’s is cheaper than Sprouts Farmers Market. Sprouts often has a few rock-bottom deals they feature prominently, but on average, Trader Joe’s is almost always less expensive than Sprouts across the entire store.

What is worth buying at Sprouts?

Here are a few of my favorites: Sprouts brand organic tahini and creamy organic peanut butter, Nuttzo, Santa Cruz organic peanut butter, and Sunbutter no sugar added sunflower seed butter. Spices, coffee spices, and teas.

What kind of store is Sprouts?

What is Sprouts Farmers Market? Sprouts, a healthy grocery store inspired by farmers markers, sells fresh, natural and organic groceries. It opened its first store in Chandler, Arizona, in 2002, according to its website. Sprouts now has more than 280 stores in 15 states.

How many stores does Sprouts have 2022?

There are currently 126 Sprouts Farmers Market grocery stores in the state of California, more than double that of any other state in the nation.

Where does Sprouts get its chicken?

Where does Sprouts get their chicken and meat? Sprouts’ chicken and other meat are sourced from the US and grass-fed beef from Uruguay. It also offers USDA Choice Natural Beef that’s been fed with grain and corn. Its chicken is described as “farm-fresh,” whatever that means.

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