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Sprouts pulls off the most successful IPO in two years

January 1, 2014

3 Min Read
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On July 31, after the bankers and lawyers and consultants had finished their diligence on the offering, Sprouts Farmers Market (NASDAQ: SFM) came to market at $18 per share. By close of trading, the company had more than doubled, reaching $39.86 per share for a one-day gain of 121%. Sprouts raised $344 million through the process—though it left just as much on the table by underpricing the offer—and landed on Wall Street with a valuation in excess of $5 billion. Looks like the public markets still have an appetite for natural & organic, especially the retailers of said products.
The Sprouts IPO follows on the heels of successful IPOs at Fresh Market and Natural Grocers by Vitamin Cottage, both still trading at hefty multiples to current earnings. According to presentations from recent earnings calls, Sprouts operates 167 stores in eight states, with customer demographics that support a near doubling in existing markets across the southwest. Potential markets nationally offer greater expansion opportunity, and, of course, increased competition with Whole Foods Market and its stated goal of 1,000 stores by 2021.
Comp store sales growth at Sprouts is forecast for full-year 2013 at 9.5%, and the company added 19 new doors to the mix last year. EBITDA and net income demonstrated dramatic growth, and Sprouts is anticipating 15% total sales growth ongoing in the long-term. So, is this the story of a frothy stock market? Of a rising tide lifting all manner of boats? Or is Sprouts up to something unique and defensible in the cutthroat aisles of grocery?
Could be all of the above. According to James Richardson, senior vice president of Hartman Strategy, a new division of the Hartman Group, “In the last decade, we’ve noticed that the drivers of interest in natural foods have broadened in the middle class. It used to be primarily people with niche dietary preference issues related to health, but we now see a broader interest in less-processed food across the U.S. population. That interest is spreading to zip codes and markets where that wasn’t traditionally much of a big deal.”
This plays right into Sprouts’ hands, as the company has proven itself savvier than most at targeting the right markets for expansion. “Sprouts has been very smart about going into under-penetrated locations for high quality natural foods retail,” says Richardson. “Modesto, California is a great example. That store is packed, and it’s not a market you’d associate with natural foods. There was a definite gap there for the classic health market consumer, but also for that produce department.” Sprouts is known for its unique set of proportions. The company overweights fresh produce with a much larger store footprint than Whole Foods and other competitors like Trader Joe’s. “That’s a big part of their identity,” says Richardson, “but they’re also a great operator. The theater of running a health food chain is no easy feat.”
Leading indicators of performance indicate strength across the board for publicly traded natural products companies, with Hain Celestial (+61%), UNFI (+37%) and Whole Foods (+26%) posting impressive 2013 returns. So where’s the risk going forward? “Middle-class cash-flow health is always a risk to a fresh-food-based business model,” says Richardson, “but in the near term, the upside is pretty bankable. That’s why investors are interested in the channel.
“These are growth models that depend on store openings and maintaining same-store sales, but that’s a classic set of risks. I’d point to Fresh & Easy as an example of operational risk. They expanded too fast and went into zip codes where the proposition was irrelevant. Store development needs to be extremely deliberate. Getting overexcited can get you into real trouble in retail.” Perhaps the greatest risk to Sprouts delivering on its high-profile IPO is in the details then, as the company balances the pressures of public demand for growth with the deliberate and targeted path to growth that got it here in the first place.

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