Sprouts Farmers Market Inc (NASDAQ:SFM) competes in the fast growing and suddenly competitive natural and organic grocery sector against the likes of The Fresh Market Inc (NASDAQ:TFM), Natural Grocers by Vitamin Cottage Inc (NYSE:NGVC) and Whole Foods Market, Inc. (NASDAQ:WFM). The sector has become pricey so is the stock or any of the stocks worth buying now?
Basic details
Sprouts Farmers Market Inc (NASDAQ:SFM) now operates 163 stores in only eight states with plans to grow the store base at a 12% annual rate. The company will open 19 stores for the year and 20 stores in 2014 with the eventual goal of reaching 1,200 locations in the U.S. Quarterly revenue has recently topped $600 million with Q1 adjusted net income growing from $16.6 million to $19.6 million or roughly 18%.
The company raised $344 million in net proceeds by selling 20.5 million shares at $18. The proceeds from the offering will be used to pay down debt and allow for a reduction in the interest rate on a credit facility. Apollo Management is a large shareholder that could provide selling pressure in the future with the stock at these levels.
The stock is valued at over $6 billion or roughly 3 times the trailing revenue base. As an example, Whole Foods Market, Inc. (NASDAQ:WFM) only trades at 1.5 times expected revenue. The Fresh Market Inc (NASDAQ:TFM) has been public for a while and it trades at only 1.7 times revenue.
Sector potential
With the massive store growth of the smaller firms of The Fresh Market Inc (NASDAQ:TFM), Sprouts Farmers Market Inc (NASDAQ:SFM), and Natural Grocers by Vitamin Cottage Inc (NYSE:NGVC), the sector has the potential to grab a larger portion of the overall $600 billion U.S. supermarket industry. According to Nutrition Business Journal, spending on the natural and organic sector has been growing at a rate of 10% annually with sales only reaching $43 billion in 2011. With less than 10% of the total supermarket sector, the natural and organic industry will benefit from the greater access to the produce that the new stores bring.
Rich valuation
Investors paying more than double the IPO price of $18 must be salivating over the growth potential of Sprouts Farmers Market Inc (NASDAQ:SFM) with locations in only eight states. This compares favorably to Natural Grocers by Vitamin Cottage Inc (NYSE:NGVC) in 13 states and The Fresh Market Inc (NASDAQ:TFM) with locations in just over 20 states. Ironically, all three grocers have recently ventured into Oklahoma with plans for multiple locations in Tulsa. This state and the metro areas of Oklahoma City and Tulsa could provide the ultimate research as to which operation will ultimately succeed in dominating the plans for nationwide rollouts.
As mentioned above, Sprouts Farmers Market Inc (NASDAQ:SFM) trades at market value exceeding $6 billion with revenues of $2 billion in 2012. The company reported revenue of $622 million for the quarter ending June 30 with growth of 22%. This compares to a sector that generally trades at 2 times trailing revenue making Sprouts the most expensive in the group. Especially considering the company isn’t overly profitable with razor thin profit margins in 2012 of around 2%. Hard to fathom that adjusted earnings of $45 million could justify a valuation of $6 billion in the grocery sector no matter the strong growth potential. The Q1 results provide some hope as adjusted profit margins hit 3.4%.
Bottom line
Based on recent shopping experiences at a new Sprouts store in my metro area, it was shocking to see the IPO price above the range. The surprising part was the magnitude and valuation afforded the stock compared to other industry players. Sprouts appears a top notch operator, but razor thin profit margins make the current valuation difficult to swallow. Sure the $6 billion stock has all the makings of competing well against sector leader Whole Foods Market, Inc. (NASDAQ:WFM) down the road, but investors need to wait for a discount on the stock to justify buying. Remember that Whole Foods has mentioned more competitive pricing and that could impact competitors such as Sprouts.
The article This IPO Sprouted Too High originally appeared on Fool.com and is written by Mark Holder.
Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool recommends The Fresh Market. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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