How Attractive is Sprouts Farmers Market SFM Stock

Sprouts Farmers Market Inc (NASDAQ: SFM)

Imagine walking down aisles and aisles of fresh fruits and vegetables, surrounded by a plethora of natural and organic foods. Whimsical wood panelling and green letters remind you of a simpler time… perhaps a reminder of the farm and where our food comes from. Are you imagining Whole Foods Market (NASDAQ: WFM)? No, this is Sprouts Farmers Market, a smaller and nimbler version of Whole Foods. Sprouts operates in the organic and natural foods retail niche, along with other major players such as Whole Foods and the private Trader Joe’s.

Sprouts operates as a healthy grocery store that offers fresh, natural, and organic foods and describes the cornerstone of their business as offering these things at attractive prices in every department. It is located primarily out of California, Texas, Arizona, and Colorado, with growing store counts in 7 other states. It has been growing at a rapid clip over the past 5 years. It has been doing a great job at capturing market share in the giant US supermarket sector that does annual sales north of $600 billion. This is demonstrated in the growth you can see in sales and profits.

What makes Sprouts so intriguing is that it has grown revenue since 2010 from $517 million to $3.4 billion by the end of 2015, almost a 46% annual average growth rate. Net income has grown from $5 million to $119 million, representing around 88% annual average growth. Earnings per share has clocked in annual average growth of almost 58%, with the discrepancy from the net income growth figure primarily due to some share dilution with shares outstanding growing from 64 million to 156 million by the end of 2015.

In addition to this stellar growth in its income statement, the balance sheet has remained consistently healthy, with current assets sufficient to cover current liabilities, and total assets always eclipsing total liabilities. The cash flow statement shows cash from operating activities growing closely in parallel with revenue growth, witnessing a 57% annual average growth rate as it went from $22 million in 2010 to $209 million by the end of 2015. Not only that, free cash flow has grown from $5 million to $81 million, an impressive 75% annual average growth rate.

At the current stock price of around $23 per share and expected earnings per share in 2015 to close out around $0.83, the stock is currently priced at around 28 times earnings. Revenue growth has slowed down to 18% year-over-year in the latest quarter. Sprouts has guided investors for 15% revenue growth, or more, in the years ahead. If Sprouts can grow its earnings per share at a similar 15% going forward, in 5 years time earnings per share should reach around $1.67 per share, assuming minimal share dilution.

If we assume some P/E compression from current levels of 27 P/E down to 20 P/E by 2021, this would assume investors in 2021 are willing to pay 20 times $1.67 earnings, for a stock price of around $33.40. This represents an average annual growth rate over the next 5 years to be around 7.4%. Not bad, but not great.

The thing with Sprouts is that, like any small growing company, the high expectations baked into the price-to-earnings multiple means that it needs to execute flawlessly and surpass all expectations for the stock to provide a better than market return. While Sprouts is a compelling stock based on its previous 5 years growth history in revenue, profits, and cash flow, the realistic guidance of around 15% revenue growth into the future at current earnings multiples for the stock is a little detached from reality.

Sprouts’ combination of its healthy balance sheet, growing revenue and profits, and consistent cash flows makes it a compelling company to add to the watchlist. But at current prices, I would look elsewhere while waiting for a potentially lower entry point to open up.

Disclosure: This author has no positions in any stocks mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.