Sprouts Earnings: Solid Sales Growth Suggests Turnaround Work Is Paying off, but Shares Not Cheap

Our $30 per share valuation of no-moat Sprouts SFM should rise by a mid-single-digit percentage (similar to the afterhours trading price reaction) after the company reported first-quarter earnings that have it trending higher than our full-year targets. However, we believe long-term competition will limit the firm’s prospects and believe this dynamic is inadequately reflected in the shares’ premium trading price. So, we suggest investors await a more attractive entry point.

Comparable sales grew 3.1%, above our 1.5% full-year target as the company passed on rising costs to consumers more successfully than we anticipated and as e-commerce delivered gains. Sprouts’ 9.7% adjusted EBITDA margin rose around 40 basis points, spurred by cost leverage. Management lifted full-year earnings guidance in response to the strong quarter, now expecting $2.58 to $2.68 in adjusted diluted EPS (previously $2.41 to $2.53). Our $2.55 forecast should rise into the new range.

We are encouraged that recently opened locations are outperforming management’s sales targets, a validation of the chain’s shift toward smaller, simpler stores (a move we had viewed favorably). We believe that the new format offers greater efficiency while focusing the offering on the company’s core value proposition (particularly attractively-priced fresh and health attribute-oriented items). The company plans to open 19 stores (excluding licensed store acquisitions and net of closures), and management indicates the pipeline should support 10% unit growth next year, which is modestly above our 8% estimate.

Still, as inflation eases and supply chain conditions normalize, we anticipate the unfavorable competitive dynamics which had plagued Sprouts prior to the pandemic will re-emerge. As a result, we still expect the company will struggle to keep operating margins from dipping toward 3% (from 5.6% in 2022) over the next decade as larger grocers increasingly set their sights on growth from health-oriented items.