There are many things to like about Sprouts Farmers Market. This business is easy to understand because it sells food. The company aims to become a leading provider in attribute-driven, health-focused categories, such as organic, vegan, grass-fed, and Keto, setting itself apart from many of its competitors. Finally, it operates in a market that is expected to grow at a compound annual growth rate of 11% until 2030.
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Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Sprouts Farmers Market. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Sprout Farmers Market's competitors either. Thus, I have no personal stake in Sprouts Farmers Market. If you want to purchase shares (or fractional shares) of Sprouts Farmers Market, you can do so through eToro.eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Sprouts Farmers Market was founded in 2002 in Arizona, United States. In 2011, it acquired Henry's Sun Harvest and Sunflower in 2012. Sprouts Farmers Market conducted its IPO in 2013. Sprouts Farmers Market focuses on selling fresh, natural, and organic foods, which they primarily source locally. The Sprout Farmers Market shops represent a blend of farmers' markets, natural foods stores, and smaller specialty markets, which distinguishes them from their competitors. Another factor that sets Sprouts Farmers Markets apart from their competitors is their dedication of 20% of their retail space to produce, particularly fruits and vegetables. 53% of their sales consist of perishable foods (produce, meat, dairy, etc.), while 43% of their sales are non-perishable items (vitamins, frozen foods, body care, etc.). Sprouts Farmers Market also has its own private label, which contributed to 20% of revenue in 2023. By the end of 2023, Sprouts Farmers Market had 407 stores in 23 states in the United States. Their customers are typically higher-income consumers who prioritize health and selective products. I believe that Sprouts Farmers Market has established a brand moat by setting themselves apart from their competitors through the unique atmosphere they cultivate and their emphasis on offering fresh produce.
The CEO is Jack Sinclair. He joined Sprouts Farmers Market in 2019 as the CEO. Prior to joining Sprouts Farmers Market, he served as the CEO of 99 Cents Only Stores. He has also held positions at Walmart, where the Grocery Division experienced substantial growth under his leadership. He has earned a bachelor's degree in Economics and Marketing from the University of Strathclyde in Glasgow, Scotland. He also serves as a board member of The Food Industry Association. He has been credited with making Sprouts Farmers Market a more efficient, profitable, and innovative retailer. In an interview, he mentioned that being transparent is very important for a leader. This practice enables everyone to comprehend the rationale behind the leadership's actions, fostering a positive work environment where everyone feels valued and heard. I believe this is a great point. We don't have much information about Jack Sinclair, but he has shown great leadership during the pandemic and has over 35 years of experience in the industry. I am confident in Jack Sinclair's ability to lead Sprouts Farmers Market moving forward.
I believe that Sprouts Farmers Market has a brand moat, and I also hold a positive opinion of their management. Now, let us investigate the numbers to determine if Sprouts Farmers Market meets our criteria for possessing a strong competitive advantage. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. I would like a 10-year history with all figures exceeding 10% for each year. The Return on Invested Capital (ROIC) of Sprouts Farmers Market has consistently exceeded 10% since 2014, which is always a positive indicator. It is very encouraging to see that the Return on Invested Capital (ROIC) has been above 20% every year since 2020, which represents the first four full years with Jack Sinclair as CEO. Seeing numbers like these is very encouraging because not only do they exceed the 10% requirement, but the Return on Invested Capital (ROIC) has also reached a new level in the last four years. ROIC dropped slightly after 2020, but it is not something I am worried about. This decline can be attributed to the unique circumstances of the pandemic in 2020. Hopefully, Sprouts Farmers Market will continue to deliver a return on invested capital (ROIC) above 20% in the future.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers have been a bit mixed, and 2019 marked the lowest equity in the past 10 years. Ever since Jack Sinclair assumed the role of CEO at Sprouts Farmers Market, the company's equity has consistently grown each year, culminating in a new milestone in 2023. Thus, I'm encouraged to see numbers like these.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Sprouts Farmers Market has consistently generated positive free cash flow over the past 10 years, which is always encouraging to observe. It is also encouraging to see that Sprouts Farmers Market has experienced an increase in free cash flow since Jack Sinclair assumed the role of CEO, even though it has decreased slightly since 2020. However, it may be due to the unique circumstances of the pandemic, which could make the 2020 numbers a bit skewed, while macroeconomic factors have affected Sprout Farmers Market in the past two years. Levered free cash flow margin may appear low, but this is due to the industry in which Sprouts Farmers Market operates. In fact, Sprouts Farmers Market has consistently delivered a higher levered free cash flow margin compared to most of its competitors. The free cash flow yield is below the ten-year average, which suggests that Sprouts Farmers Market is trading at an expensive valuation. However, we will revisit this later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on Sprouts Farmers Market, I found that the company has 0,48 years of earnings in debt. Thus, debt is not an issue for Sprouts Farmers Market.
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Based on my findings so far, I believe that Sprouts Farmers Market is an intriguing company. However, no investment is without risk, and Sprouts Farmers Market also has its fair share of risks. One risk is competition. Sprouts Farmers Market operates within the competitive and highly fragmented grocery store industry, which includes a wide array of food retailers. This industry includes large national and regional supermarkets, small grocery and convenience stores, as well as online competitors. Some of the competitors include Whole Foods, Kroger, Target, Walmart, and Amazon. Some of these large competitors may choose to lower their retail prices and expand their promotional activities, which could reduce sales and gross profits for Sprouts Farmers Market. These major competitors may also expand their store presence to compete with Sprout Farmers Market. This is evident in the case of Whole Foods, which is introducing a new store format to enhance its market share in the grocery market. Macroeconomics. The retail food industry is sensitive to fluctuations in overall economic conditions. Macroeconomic factors such as high inflation, recessionary economic cycles, increases in interest rates, higher prices for commodities, raw materials, fuel, and other energy sources, high levels of unemployment and consumer debt, as well as depressed home values, are all factors that can impact consumer spending and confidence. These factors may significantly and adversely affect the demand for the products that Sprout Farmers Market sells. As a result, consumers could reduce their spending in Sprout Farmers Market's stores or shift their spending to lower-priced competition, such as warehouse membership clubs, dollar stores, or online retailers. This shift could potentially have a significant and negative impact on Sprout Farmers Market's operating results. Relies heavily on sales of fresh produce and quality fresh, natural, and organic products. Sprout Farmers Market has a significant focus on perishable products, accounting for 53% of sales, which includes fresh produce, natural, and organic products. The availability of such products at competitive prices depends on many factors beyond Sprout Farmers Market's control, including the number and size of farms that grow natural or organic crops or raise livestock that meet their quality standards. Sprout Farmers Market competes with other food retailers in sourcing fresh, natural, and organic products, as well as other specialty, attribute-driven products that are often less common than conventional products. If Sprout Farmers Market's competitors significantly increase these types of product offerings due to increases in consumer demand or other reasons, Sprout Farmers Market may not be able to obtain a sufficient supply of such products on favorable terms, or at all, and its sales may decrease. This could have a material adverse effect on their business.
There are also numerous reasons to invest in Sprouts Farmers Market. One reason is to open new stores. Sprouts Farmers Market expects to increase unit growth by 10% from 2024 onwards. These new stores will be smaller than the current stores, which are currently 28.000 square feet. The new shops will range between 21.000 and 25.000 square feet. This reduction in size will result in lower construction costs, as well as a decrease in non-selling space, occupancy, and operating costs. Management has stated that the new stores will have similar sales compared to their larger stores because they will focus on not losing selling space but cutting back on non-customer-facing space. This will allow Sprout Farmers Market to retain the same stock-keeping unit count in the smaller stores. It indicates that the cost reductions in smaller stores will result in increased profitability per store in the future. Private label brand. Sprout Farmers Market is expanding its private label brand, which accounted for 20% of revenue in 2023, up from 19% in 2022 and 16% in 2021. Management has mentioned that they will continue launching new Sprouts brand products and aim to increase private label sales growth beyond company performance. Typically, private label brands are more profitable than external brands. According to data from CB Insights, profit margins for private label foods are significantly higher than those of external brands. Furthermore, management also expects that the private label products will enable Sprouts Farmers Market to distinguish itself from competitors and foster customer loyalty. A new loyalty program. Sprout Farmers Market is planning to invest approximately $15 million, primarily focused on expanding its loyalty program. They will introduce the first iteration of the new loyalty program in the summer of 2024 and launch it in 2025. Management expects that the new loyalty program is a significant opportunity to increase the share of wallet among their target customers by encouraging them to visit more frequently and add more items to their shopping baskets. Management has mentioned that the loyalty program is designed to grow Sprout Farmers Market's identifiable customer base and gather valuable data on their preferences, enabling Sprout Farmers Market to personalize the experience to meet their specific needs. They are also optimistic about how the data will potentially unlock value across the business by deepening their insights on customers, aiding in brand product development for their private label. Management believes that the loyalty program can be a long-term value driver for Sprouts Farmers Market.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 2,50, which is from the year 2023. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 8,6% in the next five years. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on Sprout Farmers Market's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $21,35. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Sprout Farmers Market at a price of $10,68 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 465, and capital expenditures were 225. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 158 in our calculations. The tax provision was 85. We have 101,212 outstanding shares. Hence, the calculation will be as follows: (465 – 158 + 85) / 101,212 x 10 = $38,73 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Sprout Farmers Market's free cash flow per share at $2,36 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $27,11.
I believe that Sprouts Farmers Market is an intriguing company, and I also have confidence in the management. Sprout Farmers Market may be facing some short-term headwinds due to general economic conditions, which could put pressure on the stock price. Competition will always be a risk factor for Sprout Farmers Market, but so far, they have been able to distinguish themselves from their competitors, and there is nothing to suggest that they won't continue to do so. Sprout Farmers Market relies on fresh produce and high-quality, natural, and organic products, which are often less available than conventional products. If the number of competitors offering these products significantly increases, it could affect Sprout Farmers Market. They may face challenges in obtaining all the products they require or may have to pay higher prices. I am intrigued by Sprouts Farmers Market's new store concept featuring smaller stores, which could potentially increase profitability in the future. So far, it seems that this concept has not affected the stock keeping units, as management has successfully maintained selling space. This is very encouraging. I haven't been able to find the profit margins on their private label products, but I would be surprised if they were not higher than those of external brands. Thus, it is intriguing that the private label is growing year over year, and management is determined to accelerate its growth faster than overall sales. The new loyalty program could be a long-term value driver for Sprouts Farmers Market, especially because management has stated that they currently only have 19% identifiable transactions. This indicates that there is significant room for improvement through the loyalty program. Furthermore, Sprouts Farmers Market consistently delivers a high return on invested capital (ROIC), which, in my opinion, is the most important metric to consider when making investments. There are many positive aspects of Sprouts Farmers Market, but personally, I prefer to have a margin of safety when making investments. Thus, I will add shares in Sprouts Farmers Market if it falls to the Ten Cap price of $38.
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