Decent Q4 Trumped By Sprouts’ Strategically Cogent Store Optimization Plan; Market Too Enthusiastic

After no-moat Sprouts Farmers Market SFM posted fair fourth-quarter results (sales of $1.58 billion and diluted EPS of $0.42, in line with our $1.58 billion and $0.39) shares shot up 12% (as these marks outpaced FactSet consensus’ $1.56 billion and $0.37). Beyond a solid close to the year, we think the market’s fervor was driven by plans to optimize its store footprint (as it intends to prune 11 underperforming, larger-format boxes and add 30 smaller stores with a simpler format) in fiscal 2023. We hold a favorable view on Sprouts’ efforts to revitalize diverse facets of its business (through enhancing customer engagement, store optimization, omnichannel capability, and private-label strength). However, we think these efforts merely elevate Sprouts’ ability to price competitively, rather than improve its competitive position, underpinning our no-moat rating.

We plan to edge down our near-term forecast to align with Sprouts’ fiscal 2023 outlook (net sales growth of 4%-6% and adjusted diluted EPS of $2.41-$2.53, a tad below our preprint 6.9% sales growth and $2.54 EPS forecasts), but this should be offset by time value, rendering our $30.50 fair value estimate largely unchanged. At a 10%-15% premium, we suggest investors remain on the sidelines; we think the current valuation fails to account for its subscale position in a highly competitive industry.

In the quarter, Sprouts’ comparable store sales grew 2.9%, aided by inflation and continued strength in convenient deli grab-and-go meals. As we’ve anticipated, lower units per basket and trade-down activities persisted, as consumers are battling numerous constraints on their pocketbooks. While its recent partnership with narrow-moat DoorDash fueled ecommerce sales growth of 17% (marking an online penetration of 11.3% for the full year from 10.8% the prior year), we doubt this will prove sufficient to unlocking meaningful profit (as we forecast just low-single-digit operating margins long term).