While the stock has under performed and seen negativity since since their IPO, Sprouts has more than doubled revenues, quintupled net income, and lowered the number of shares outstanding from 154 million to the current 118 million. The latter was accomplished by returning $958 million trough buybacks since 2013 and the current fundamentals look worthwhile compared to the market capitalization of $2.3 billion. The market capitalization was $7.3 billion when the stock peaked in 2013.
The issue that Sprouts is experiencing is on their operating margins. Given the margins over the last years have narrowed, there has been a management transition and the new growth strategy is to have smaller stores for higher profitability, more growth in existing markets rather than pure geographical expansion where it is hard to scale and reach cost benefits. Management wants the format to stay true to their Fresh-focused Farmers Market Heritage, prioritize categories for growth potential and continue to offer all categories to customers. Beyond 2021, the plan is to open 300-400 new stores in expansion markets (California, Texas, Georgia, Florida, Pennslyvania and New York) which would represent a minium 10% unit growth.
Sprouts is looking to create a more concentrated delivery center (DC) supply chain so it can create advantages that'll lower logistic costs and better pricing for bargining power, which will allow for better margins!
The key is to watch whether margins will start expanding or keep narrowing as analysts fear, and as has been the case with operating margins over the past years, excluding the COVID-19 positive impact. The narrowing of operating margins is what created the pressure on the stock, alongside the fear of increasing competition from Amazon through Whole Foods and online, To Wal-Mart, Kroger and others having more and more specialty and organic offerings to hard discounters doing the same.
Goldman downgraded the stock based on the following:
The primary risk in my mind, and what everyone is watching are operating margins. If those keep declining, as the case has been since 2014, then the outlook will not be great. However, if they cna stop operating margin from continuing to narrow and execute with online sales, then the story starts to really flip.
While the upside is not fantastic, I think the most likely outcome is an increase to low $30s. In the most bearish scenario, the stock falls to $18 and with momentum sell off we hit $12 where it would likely be taken over by somebody for $15. Given all of that, the investing opportunity is giving a positive risk and reward situation.