EUR 850.00 For Business Accounts Only

Morningstar | No-Moat Sprouts Posts Solid Top-Line Gains in 2018, but Tepid 2019 Outlook; Long-Term Thesis Intact

No-moat Sprouts’ fiscal 2018 results were largely in line with our expectations. Sales grew 12%, with same-store comps growing 2% on a 4.3% operating margin near our forecasts of 11%, 2%, and 4.4%, respectively. However, management’s outlook for fiscal 2019 fell short of our expectations, calling for 9% to 10.5% sales growth, 1.5% to 3% comp growth, and diluted EPS of $1.16 to $1.24 versus our estimates of 11% sales growth, 3.5% comps, and diluted EPS of $1.39. In our view, this highlights the difficult grocery environment the firm competes in. While Sprouts continues to expand its store base and increase promotions to drive traffic, we contend that its differentiated business model, where produce accounts for roughly 15% of a store's selling square footage (higher than its peers), is placed at the center of the store, and is on average priced 10%-20% below conventional grocers, will support around 3% average comp growth over our forecast. As a result, we have confidence in our long-term forecast of high-single-digit sales growth and 5% operating margins on average, as well as 20 to 30 new stores added annually. We do not expect a large change to our $26.50 fair value estimate, as a lower 2019 outlook should be offset by the time value of money, and we view shares as fairly valued.

We are hesitant about the firm’s decision to grow higher-margin private-label sales (up 26% in 2018, 13% of total sales), as we believe that in the long run, increased private-label penetration in the natural and organics category could erode the price premium consumers are willing to pay for these products. Additionally, we continue to see execution risk as the firm expands into new markets (New Jersey, Virginia, and Louisiana in 2019), evidenced by the firm closing two stores in the underdeveloped Southeast market in 2018. We believe net store counts will grow 6% on average over our 10-year forecast, below the firm’s 13% historical five-year average.