Jhe grocery business is tough under normal conditions. Margins are thin, products can spoil, and effectively cutting costs without hurting the customer experience is no picnic.
The COVID-19 pandemic has been a boon for grocery stores as spending has moved away from restaurants, but now spending patterns are returning to normal. Combine this headwind with historically high inflation and recession fears, and you have the ingredients for a very challenging environment for grocery stores.
Earnings growth in a challenging environment
Cabbage growers market (NASDAQ: SFM) has done well during the pandemic, and the unique mix of small stores, large product section, and products based on company attributes is more than resilient to changing consumer behavior. The company’s second quarter report looked good on all fronts.
Revenue jumped 5%, driven by a 2% increase in same-store sales, and gross margin was up slightly from the prior year period. The company is seeing some customers drop as the economic environment takes its toll, but that’s not enough to really cause problems. Sprouts is actually seeing an increase in product sales in bulk because customers can buy the exact amount they need.
Higher sales, improved gross margin and lower number of shares led to earnings per share (EPS) of $0.57, up nearly 10% from the prior year period. The company spent $65 million on stock buybacks during the quarter and $1.3 billion since stock buybacks began in 2015. Sprouts’ market capitalization is around $3 billion, so this share buyback activity is significant.
The company’s outlook calls for more of the same for the rest of the year. It saw its comparable sales increase by 1 to 2%, with total sales up by 4 to 5%, thanks to the opening of 15 to 17 new stores. Gross margin is expected to increase slightly from last year and Sprouts expects to generate earnings per share as high as $2.26. EPS came in at $2.10 in 2021, for comparison.
What makes Sprouts special
Instead of cavernous stores that sell just about everything, Sprouts keeps its stores relatively small. This keeps operating costs low, which is especially important when the economic environment is as volatile and unpredictable as it is today. In fact, the company plans to reduce the size of its new stores, which will reduce construction costs and lead to lower operating costs over time.
Sprouts fills its smaller stores with lots of products and attribute-based products. About 70% of its products are attribute-based — think gluten-free, paleo, organic, grass-fed, vegan, and more. The company also offers plenty of take-out meals, and e-commerce is thriving. Just over 11% of sales come from online pickup and delivery, which is higher than during the pandemic years of 2020 and 2021.
Unlike large grocery chains that don’t have much room to expand their stores, Sprouts is just getting started. The company operates 378 stores and plans to open at least 30 new ones next year. From 2024, Sprouts is aiming for 10% annual growth in its number of stores. The company sees room for up to 400 new stores in its expansion markets, which include California, Texas and Florida.
Sprouts stock soared Thursday after its second-quarter report, but the market still isn’t giving the growing grocery chain enough credit. With a stock price hovering around $31 per share, Sprouts is trading at less than 14 times the high end of its full-year earnings forecast. If the company can achieve its goal of double-digit annual earnings-per-share growth, Sprouts stock could be worth much more in the future.
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Timothy Green holds positions in Sprouts Farmers Markets. The Motley Fool recommends Sprouts Farmers Markets. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
