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Investors and consumers alike should be concerned about the potential impact inflation may have on their businesses. Some sites, like ShadowStats.comFor many years,, have been monitoring inflation rates and reporting that they are much higher than the government reported results. ThisEfficacy is being observed in Government-produced dataFood inflation is expected to rise between 5-6% and 10% over 2022, with close to 10% YoY in food inflation. Food is not something most people can live with, and this is why inflation is so alarming. It becomes more difficult for people to afford goods that are more expensive than their income. This same effect can also affect wealth and investments for investors. Therefore, it is important to have some investments that hedge against this effect.
Sprouts Farmers MarketNASDAQ:SFM) is a specialty grocer selling largely healthy and organic food throughout the United States. Sprouts currently operates more than 380 stores in twenty-three states. The company offers a variety of products, which are aimed at more health-conscious and wealthy customers. We will examine how Sprouts shares can provide some resistance in an inflationary environment, as well as its relative valuations and potential risks to this thesis.
An Inflationary hedge
All companies in their supply chains will be affected by inflation, locally and globally. Companies must understand how price sensitive their customers are and what risk they face in an inflationary environment. The pricing premium that organic and health food businesses receive is due to extra health disclosure requirements, perceived higher quality, and a higher price. This is the nature of the market. These costs have been largely accepted by customers in the space, going back on Whole Foods’ “Whole Paycheck” reference. These customers are more affluent and have less disposable income. This allows them better to manage price increases. This makes it easier to pass costs onto customers.
This is a risk because there may be substitutes for these goods. Customers who feel the pinch from higher Sprouts grocery bill prices could look into other options. Both Kroger (KR), and Albertsons (ACI), are both publicly traded alternatives that offer lower costs. Those who feel these impacts could trade down and move to these lower-cost alternatives, although this has always been a risk for Sprouts. These mainstream grocers will also be passing on the costs to customers. Sprouts’ wealthier customer base will likely make it more resilient than those with lower margins. Sprouts also has a good private label base with about 16% of its listed products being privately labeled. These products could be used as internal trade-down options if customers aren’t ready to move stores.
Valuation
It is worth looking at the value of grocers in the last few years because the trend towards healthy eating has been there for some time. The valuation perspective was great because we had a great barometer to use for the valuations of grocers. 2017 purchaseWhole Foods Markets by Amazon, AMZN (10.1x EV to EBITDA). It was also noted that multiples were paid for regular grocery stores at the time, such as Albertsons’ acquisition Safeway at 5.5x EBITDA.
Sprouts has seen a 57% increase in EBIT since then, including a “bubble” performance during COVID, which is due to the impact of other options like dining out.
Seeking Alpha, Company Filings
With the market advancing and high-priced sales stocks beginning to see sell offs, EV/EBITDA multiples are likely to be a better metric for Sprouts’ valuation at this point. Below is a comparison of Sprouts’ performance compared to its larger grocery rivals on a valuation, cash flow and EBIT margin basis.
We can see that the company’s valuation has increased by nearly four turns of EBITDA since the Whole Foods acquisition. This is despite the company’s continued growth. Its valuation is comparable to its competitors, particularly considering its higher profit margins. There are many growth opportunities for the company as it has a presence across less than half of the US states.
The company has a strong share buyback program that has helped reduce its share count by 18% in the past five years. This will help to increase its financial performance.
Sprouts has announced a new $600m buyback. It replaces the $100m one that was in place, which expires December 2024. This would reduce the share outstanding by almost 20% at its current market value of $3.2B. This is a good capital management strategy, considering that multiple shares at a discount are still trading at the same price as the shares. It also provides a built-in option to purchase the shares.
Risques
As I mentioned earlier, the biggest risk is whether Sprouts can pass on the inflation costs to its customers. Given the size of the customer base, I believe this is possible. The supply chains are at risk as we see the effects of COVID and geopolitical tensions, making everything slower and more expensive for everyone. However, this is not a problem that Sprouts is facing.
Analysts have always placed a lot of importance on margins. Sprouts’ ability maintain them will be a key focus. There was some flux as the COVID pandemic caused a temporary tailwind to the company’s performance. However, it has since returned to a normalized level. Sprouts will release its earnings after-market on May 4.ThThese could act as a catalyst for up or down in the market’s volatile environment. This is a short-term issue, but it will be interesting for the company to update its guidance for next year based on Q1’s performance.
Summary
Since the beginning of time, investors have not had to deal with an inflationary environment. Sprouts Farmers Market is a good hedge because of its target market, operational performance and ability to pass on escalating price increases.
