Sprouts Farmers Market (NASDAQ: SFM) Has Reasonable Valuation But Keep Growth Expectations in Check

Sprouts Farmers Market NASDAQ: SFM, a grocery chain that sells fresh, natural, and organic food products, has seen business pick up since the onset of the pandemic. With closures and social distancing requirements putting a dent in the restaurant sector, grocery retail has been the beneficiary.

SFM is trading at a reasonable valuation but has underperformed its peers. Is it still a buy?

How Does Sprouts Farmers Market Compare to the Grocery Retail Sector?

For most of Q1 2020, Sprouts Farmers Market was on pace for little growth – around 1% yoy. But the pandemic provided a huge boost to the quarter in March. Comparable store sales increased 26% in March, which bumped comps to a gain of 9.6% over Q1 2019. April wasn’t quite as good, but comps were still up 7.2% yoy.

Sounds great for a slow-growing company, right?

Not when you compare it to the grocery retail sector. The sector saw 30.9% yoy growth in March and 13.2% yoy growth in April. This means that SFM is lagging by around 5-6%.

During the Q1 earnings call, CEO Jack Sinclair gave his take on the underperformance, saying the “majority of grocers have had a very big uptick on what you would call paper products and bleaches and all the obvious things that have come flowing through in that. We're not really in that space.”

This makes sense but doesn’t really explain the April underperformance as people were “prepping” the most in March.

We’ll have to wait until the Q2 earnings report to get SFM’s May and June data, but we have data from the U.S. Census Bureau on the sector for those two months. In May, the sector was up 14.4% yoy and in June, it increased 11.7% yoy. If March and April trends hold up, SFM would see roughly 6-9% yoy growth in these two months, giving it mid to high single-digit growth for the quarter.

But Sprouts Farmers Market is Still a Reasonable Value

Sprouts Farmers Market may be lagging its peers, but there’s a lot to like when you look at its valuation metrics.

The company is trading at around 15.5x projected 2020 earnings and just under .5x projected 2020 sales. It has seen double-digit annualized revenue growth over the past year, three years, and five years. That double-digit revenue growth may continue this year, but low single-digit growth may be more realistic in 2021 and beyond as the pandemic becomes less of a factor.

In Q1, gross margin increased to 36.1%, up 180 basis points yoy. SG&A was 26.5% of sales, flat compared to a year ago.

The company’s average basket was $51, nearly double its long-term average, as customers bought moreover fewer trips to the physical locations and started to buy online more often.

SFM’s e-commerce business is the biggest reason for long-term optimism. In April, e-commerce sales were up 950% yoy and represented 13% of the company’s sales for the month. SFM recognizes the potential of e-commerce and is investing aggressively in it. While the end of the pandemic will cause many people to shift back to grocery shopping at brick-and-mortar locations, habits are sticky and there will likely be lasting gains from the pandemic.

Again, while high revenue growth is unlikely in 2021 and beyond, e-commerce can drive modest growth. Couple that with a demonstrated ability to increase margins, and SFM starts to look appetizing at under 16x projected 2020 earnings.

Sprouts Farmers Market - You Have A Couple of Entry Points

SFM didn’t dip much when the market tanked at the onset of the pandemic. Over the past two months, shares have been basing between around $22.50 and $26.80. A breakout would mark a 52-week high.

Waiting for a high-volume breakout above $27 is one option.

But you could also look to get in now. Shares are currently sitting just above the 50-day moving average. Over the past five trading sessions, the price action has been solid, with higher volume up-days and lower-volume down days. SFM has closed near-daily highs over the past week, another good sign.

Furthermore, if you get in here, you can use the July lows of $23.68 as a line in the sand (it would best to place the stop 10 or 20 cents below). That would give you a reasonable downside of around 8% and the stock would have to convincingly breach the 50-day moving average for you to be stopped out.

Of course, you could wait for the breakout. There’s an argument to be made for waiting and seeing if it can breakout before buying. But if you get in now, you have a nice early entry point with a logical (and close) line in the sand on a stock that looks primed to move higher.

The Final Word

Nobody is going to mistake SFM for a high-flying growth stock. But the valuation is attractive, and it deserves a place in your portfolio. Whether you look to get in now or wait and see on a breakout, don’t lose sight of SFM.