Sprouts Farmers Market (SFM) – From Seed to Plant

facade of a Sprouts Farmers Market store

In a stock market that is one of the most expensive on record, we think that our emphasis on attractively valued, unpopular, or unknown stocks is especially appropriate. The most popular companies – notably technology companies such as Amazon, Google, Apple, and Microsoft – are thriving as businesses. Their stocks are another matter, however, as past market cycles have shown that such stocks have an extremely high risk of large price declines when the broad stock market turns down.
Sprouts, whose stock had been popular and pricey when it had its initial public offering five years ago, was recently treated more like spoiling fruit. When it went public in 2013 amid hype about the growth prospects of the natural and organic food business, the stock was expected to trade for $18 but closed the first day at $40. Five years later, the stock recently sold for $20. (That’s a good example of why we don’t invest in initial public offerings, or IPOs.)
Sprouts has a business that we admire. It aspires to bring fresh produce to shoppers at reasonable prices. Ninety percent of its products are natural or organic. Sprouts has smaller stores than its peers, with an open layout intended to resemble a farmers’ market. Despite an intensely competitive business, and with new competition emerging all the time (Aldi and Lidl most recently), we think there is still room for Sprouts to increase the number of stores and continue to grow.
The company has made efforts to cultivate its sustainability program. Sprouts has committed to addressing food waste, a leading contributor to climate change, by diverting over 90% of its through donations to food to hunger relief agencies, local farms for animal feed, and compost. It is also working to improve its sourcing practices, particularly as it relates to seafood, eggs, and beef. It discloses workforce diversity data and reports that it has done a greenhouse gas inventory (though the results have not yet been disclosed). While we are encouraged by these early efforts and place huge value on increasing accessibility to fresh, organic food, we expect to see the company’s transparency on these issues improve in the next year.
As for stocks versus businesses, we’re always trying to assess the investor expectations that are reflected in stock prices. High expectations (and valuations) often lead to disappointment and falling stock prices, and low expectations (and valuations) typically lead to higher stock prices.
For Sprouts, when it came public five years ago, stock analysts had forecast annual earnings growth of nearly 40%. As the company faced growing competition, earnings growth slowed and the stock priced plummeted (which is not uncommon among popular companies that are growing rapidly). Several weeks ago, the stock price seemed to reflect earnings growth of about 10%, which we think is reasonable.
Though the stock wasn’t cheap, it was affordable relative to its own history, as well as to the consumer staples sector overall (which is currently our favorite sector). We upgraded our view of the stock and intended to start buying it. Unfortunately, that day the stock price jumped 12% when the company announced better quarterly profits than analysts had expected. So, we waited for it to come back down a bit—but the stock kept climbing—and climbing. It has risen nearly 35% since we upgraded our rating on the stock, so we won’t be buying it anytime soon—and maybe not at all. You see, we’re very price-sensitive, value investors. The starting price of an investment is crucial, no matter how good the company’s story. So, for now at least, Sprouts is “the fish that got away.” We will be patient at the checkout line and wait for Sprouts to come back in price or perhaps find something else that whets our appetite.