Sprouts Farmers Market: A Peter Lynch Story (NASDAQ:SFM)

The good thing about investing in individual stocks is the availability of thousands of stocks to choose from. If you need to replace a stock that is performing poorly, you have plenty to choose from. The bad thing about investing in individual stocks is also the availability of thousands of stocks to choose from. It is impossible to track and keep up with more than a couple of dozen stocks for most of us. Peter Lynch had a solution or at least a suggestion for the “bad thing” as he recommended buying shares in companies that we, as consumers, are familiar with. Despite knowing this and shopping here for years, I’ve never owned shares in Sprouts Farmers Market (NASDAQ:SFM). I was wondering why that was the case. Perhaps it could be as simple as not even realizing that Sprouts is a publicly listed company and the presence of more established (as publicly traded stocks) competitors like The Kroger Co. (KR) and Target Corporation (TGT).

Personal Experience

Where I live (suburb of a major metro city), Sprouts, surprisingly operates almost as a monopoly when it comes to offering a wide selection of natural and organic foods. Every single time I’ve purchased there: produce, juice, peanut butter, or even candy, the quality stands out, making us go back to purchase the same and other items.

I’ve been to three locations in different States and each one delivers on their stated idea of the magic of the Market. The store layout, general ambience, options to choose from, and quality help in the overall experience.

“Our idea of a farmer’s market: spacious and bright, open rain or shine, with plenty of treasures to discover “

But I did feel the price pinch at times. While Sprouts will undoubtedly dent your Wallet more than the neighborhood Walmart (WMT), the right comparison is within its genre. Whole Foods, now a subsidiary of Amazon.com (AMZN) is the first name that comes to mind in this space and as shown in the table below, Sprouts is way cheaper in every single category below. This comparison yielded similar results in favor of Sprouts in Organic Produce, Non-Organic Produce, Dairy, Meat, Frozen Foods, Non-Perishable, Fresh Prepared Food, Packaged Snacks, and Beverages.

Growth Plans

As a sign of their confidence, the company has plans to add 30 additional stores in 2023 and even more in 2024 as covered in this article. Doing this when retailers in general are struggling with inflation and competition shows their conviction.

While the company operates in nearly 25 States now, it sees Florida as a stand out opportunity. Why? I’d say the rich and retiring population that move to the State? Older and wealthier people are more inclined to shop for health with price not being as big a factor as for the rest of the population.

In addition, what I like about Sprouts’ expansion strategy so far is that it seems to be following the Walmart model when it comes to expansion. That is, expanding in geographical Clusters that makes sense from both logistics and business standpoint, as shown in the map below. If asked to predict tomorrow’s weather, you’d do well more often than not by using today’s actuals. Similarly, a business that expands carefully from one State to the other nearby, is likely to find that consumer behavior in one State is very similar to that in the neighboring State. Of course, there will be exceptions but the norm makes sense.

Values

I typically keep investing and morals separate, as crude as that sounds. For example, despite being a non-smoker, I hold a large position in Altria Group, Inc. (MO). With Sprouts, the moral angle aligns as well as the company’s foundation strives to provide access to fresh and healthy food to all children. Make no mistake about it, this is all part of their business strategy but what’s not to like about this motto?

In addition, the company is known to support local farmers. By local, the company means within the State or within 500 miles. This ensures support from local consumer as well as fresh food. In addition, the company cares about its employees and was one of the most proactive when it came to ensuring the safety of its employees during and even before the COVID 19 Pandemic.

Financial Analysis

None of the business qualities described above may help investment returns if the company is struggling to be profitable consistently. It appears like Sprouts does not have that problem as shown by the profitability rating on Seeking Alpha below. Digging a bit deeper, it is clear that Sprouts is managing its resources well.

• For a smaller business pursuing growth, I pay more attention to their ability to produce returns on invested capital (“ROIC”) as they need more capital to establish themselves. Smart capital deployment provides multiple benefits including potential to borrow more in the future and keeping debt situation in control. Sprouts’ ROIC stands at an impressive 11.10% which puts it in the range of giants like Walmart and Target.
• Profit margin is 17% higher than the sector median as shown below.
• Free cash flow has more than doubled in the last five years and has been increasing YoY except for a blip in 2021.

The fact that total long-term debt has been flat over the last couple of years tells me that the company knows how to run its business profitably while being self sufficient.

Is the Stock a Buy here?

A well run company does not immediately translate into a “Buy” rating for the stock though. With an expected annual EPS growth rate of 7.70%, Sprouts is trading at a price-earnings/growth (“PEG”) ratio of about 1.70, which isn’t excessively attractive but isn’t terrible either. A median price target of $33 does not offer enough margin of safety buying here. I consider the stock a “Hold” here but it is going straight into my Seeking Alpha “Watchlist” portfolio and I suggest that readers do the same.

Conclusion

In the busy world of investing (and life in general), it is easy to not realize that we, as consumers, hold powerful information that even the full time analysts may overlook. While Sprouts is not an obscure company or stock by any means, it lacks the fanfare and that might be a blessing in disguise for those who can buy the stock at the right time. Being the happy customer that I am, I look forward to the day I will be a happy shareholder. Until that opportunity arises, I will continue monitoring the stock here on.