About halfway through Wednesday trading, 314 stocks on the NYSE and Nasdaq are trading at 52-week highs, more than five times the 52-week lows.
One of the stocks catching my attention is Phoenix-based grocery store Sprouts Farmers Market (SFM). It’s hit its 84th 52-week high of the past 12 months at $154.55, which is also a 10-year high.
Up 213% in 2024 and 263% over the past year, this party seems unlikely to carry on much longer.
Is it too late to buy for gains in 2025 and beyond? I’ll ponder that question.
For everyone in transit today for Thanksgiving, do be safe.
Why Such a Move for Sprouts?
When it comes to grocery stocks, the only one I pay attention to is Costco (COST). Oh, sure, occasionally, I’ll take a peek at what’s up with Kroger (KR), but the industry does not yield too many big-time winners in the markets.
That said, until February, Sprouts stock has never traded over $50. The chain of natural and organic grocery stores went public in August 2013, selling 18.5 million shares at $18, two dollars higher than the top-end of its IPO range of $14 to $16. On its first day of trading, its shares doubled. It took another decade for its share price to move into the $40s.
Now trading in the $150s, it would be nice to understand what prompted such a move. As I scan the internet, the general consensus is that it’s happened as a result of strong expansion and a leading position within the healthy and organic grocery store market.
According to its Q3 2024 earnings release, the company expects to open 33 stores in 2024, bringing its total to 440 spread across 23 states. It opened nine in the third quarter alone. Its 2023 annual report says it has plenty of years ahead, with 10% annual growth in new store openings. At this rate, it will get well over 500 in 2026 and to 1,000 by 2032. Sprouts had 160 stores when it went public in 2013.
What do you know? Its compound annual growth rate for store openings since its IPO is slightly less than 10%. That’s consistency for you.
CFO Curtis Valentine said this in the Q3 2024 conference call about its expansion:
“We opened nine new stores during the third quarter, ending with 428 stores across 23 states. We are excited about the new store success and expanding our growth to more communities. We have nearly 110 approved new stores and more than 70 executed leases in the pipeline for the years ahead,” Valentine said.
“Our strong and healthy balance sheet has been the foundation of our financial performance. Through the third quarter, we generated $520 million in operating cash flow, which enabled us to self-fund our investments of $132 million in capital expenditures net of landlord reimbursement to grow our business.”
That’s helpful to know.
The second part, about market share within the healthy and organic grocery store market, focuses on the “health enthusiast” as its target customer.
“Our target customer over-indexes on lifestyle choices and seeks better-for-you grocery options and innovative, quality products to support their healthy lifestyle. We believe they are engaged and connected to what they eat – how it makes them feel, where it comes from and the role it can play in their lives,” states the 2023 10-K.
“Our target customer covers a wide range of incomes and age demographics – from Baby Boomers to Generation Z – and seek a variety of healthy and organic options in addition to a great store experience.”
To do this, you’ve got to walk the talk. It does.
As CEO Jack Sinclair said in the conference call, organic products account for 46% of Sprouts' total produce sales. At the same time, Sprouts is keeping the shopper’s budget from exploding by launching more than 300 Sprouts brand items, which generally cost less than brand-name products, while maintaining and enhancing profit margins.
It’s fair to say that the company is very focused on meeting the needs of its target customers, whether that’s in-store or online. It stresses that it will do what the customers want to keep their business.
Sounds good to me. But there’s more to the story.
Sprouts’ Financials Are Excellent
Three numbers stand out in the Q3 report.
First, comparable store sales grew by 8.4%, leading to net sales of $1.9 billion, 14% higher than a year earlier. Second, its gross margin in the quarter was 38.1%, 150 basis points higher than a year ago and 500 basis points higher than Q3 2019, before the pandemic. That led to adjusted earnings per share of $0.91, 40% higher than Q3 2023.
Lastly, the CFO wasn’t joking when he said it had a strong and healthy balance sheet. It finished the third quarter with no long-term debt, nearly $310 million cash, and $1.65 billion in operating lease liabilities, just 11% of its market cap.
It does have excellent financials.
Grocery stores have terrible margins. They’re doing lots of volume to make a single-digit net margin. In the first nine months of the year, Sprouts’ net income was $301 million from $5.72 billion, a net margin of 5.3%. By comparison, Kroger’s was 1.9% in the trailing 12 months ended Aug. 17, according to S&P Global Market Intelligence.
Interestingly, despite consumers' ongoing concerns about inflation, the high cost of groceries, etc., Sprouts has been able to grow its target customer base.
“‘Sprouts appears well positioned to benefit from a healthy-eating wave,’ he wrote in a research note. ‘Despite a slowing grocery retail landscape, Sprouts upper-income/health-conscious consumers are proving loyal,’” Bloomberg reported September comments from Evercore ISI analyst Michael Montani.
Unfortunately, most analysts are staying on the sidelines due to valuation concerns. Of the 18 that cover SFM stock, only three rate it a Buy, with an average target price of $134.08, well below where it’s currently trading.
Sprouts expects to earn $3.66 a share at the midpoint of its adjusted EPS guidance. It trades at nearly 42x this estimate.
Is it too late to buy? It’s never too late if your time horizon is forever. That said, despite it ticking many of the boxes for a long-term buy, I’d try to use options to get a better entry point.
Try selling the March 21./2025 $120 put for income and potentially a better buy. The $2.00 ask price has an annualized yield of 4.2%. If you want a higher return on your put, you’ll want to look for a shorter DTE.
Other than valuation, it’s a keeper.
