Is Sprouts Doomed?

These are the best and worst of times for Sprouts Farmers Market (NASDAQ: SFM). The discount organic grocer just opened its 300th store at a time when internet-enabled grocery delivery threatens its very existence.

Sprouts dramatic expansion continues with the company opening its first store in Maryland and its 300th store in South Carolina, Produce Retailer reported. Planned growth is even dramatic, the company has signed 40 leases for new stores and is has 47 approved store sites.

Kroger and Ocado Threaten Sprouts

That expansion is threatened by retail giants’ delivery plans. The most dangerous of those giants, is Sprouts’ biggest direct competitor Kroger (NYSE: KR). Kroger has plans to bring online grocery delivery to 40% of American households with Instacart’s help.

A more dangerous relationship is with the British Ocado Group PLC (LON: OCDO). Kroger and Ocado signed a deal to build 20 highly-advanced fulfillment centers across the US. Each center will use swarms of robots to pull and pack orders for delivery. Kroger owns 6% of Ocado which operates a grocery delivery service similar to Instacart in the UK.

These centers will allow Kroger to expand into areas of the country where it currently lacks brick and mortar supermarkets, Kroger CFO Mike Schlotman predicted. That sounds like direct competition for Sprouts, because Kroger targets the same middle-class customers with low prices and similar products.

Kroger offered delivery from 872 stores; many of them in direct competition with sprouts, a February 2018 press release stated. Kroger wants to expand delivery and curbside pickup to another 500 stores by the end of 2018. Around 1,091 Kroger supermarkets were offering curbside pickup of online orders in February 2018.

The Danger from Amazon to Sprouts

An equally dangerous foe is Amazon (NASDAQ: AMZN) which bought Sprouts’ archrival Whole Foods Market last year.

The Amazon Whole Foods relationship is a direct threat to Sprouts because Amazon is a deep discounter. News reports indicate that Amazon is slowly shifting Whole Foods’ business model to discount. Amazon is also expanding its GO stores, which are a sort of automated Aldi.

Amazon is testing a same day grocery delivery service in Los Angeles County for Prime Members. That service can be a template for delivery services in regions like New York City and Chicagoland.

How Delivery Threatens Sprouts

Delivery can destroy Sprouts because it keeps customers away from Sprouts where they can see its low prices.

Traditional supermarkets depend heavily from all the spur-of-the moment purchases from shoppers in the store. How many times have you walked into a supermarket to “grab a couple of things” and ended up pushing a full shopping cart out the door?

Online shoppers only get what is on their shopping list, because they are not in the supermarket to get tempted by that extra stuff. That is good for customers’ pocketbooks but bad for Sprouts’ bottom line.

The traditional supermarket is a marketing machine cleverly disguised as a food store. Grocers fill their stores with temptations such as endcaps, free samples, delis, and cafes. The online shopper sees none of that stuff.

Delivery is a double threat to discounters like Sprouts because they depend on customers seeing the low price in store and buying more. The customer comes in for the bargains and buys more.

A huge problem for Sprouts is all the people who simply hate shopping. Delivery services give those people an excuse to never go to the store, which they will happily accept. Other threats are the growing number of Americans without cars, and an increasingly urbanized neighborhood.

Can Sprouts Survive?

Sprouts CEO Amin Maredia claims that his company can whether the delivery storm by linking up with an Instacart, Supermarket News reported.

The problem with that is Kroger’s relationship with Instacart. An even greater threat for Sprouts is Kroger is simply buying Instacart. That would enable Kroger to shut Sprouts out from delivery markets.

The good news for Sprouts is that online delivery is tiny – Maredia claims it accounts for just 2.5% of U.S. grocery sales. The bad news is that delivery use can expand fast, as Amazon and Instacart’s break neck growth demonstrates.

The real problem for Sprouts is that it might not have the resources to scale delivery on a large basis. Like Whole Foods, another expansion-happy company, Sprouts is likely to run out of money and go begging for acquisition to get enough to keep operating.

Sprouts’ Limited Resources

The resources at Sprouts are very limited, Sprouts reported an operating income of $79.68 million, a net income of $66.62 million and a gross profit of $387.05 million for 2nd Quarter 2018. Those figures came from quarterly revenues of $1.287 billion.

Sprouts’ total assets on April 1, 2018 were $1.627 billion and it had just $2.36 million in cash and equivalents on the same day. That indicates Sprouts can run out of cash fast, and find itself begging for acquisition.

Sprouts’ cash is very limited it only $60.33 million in free cash flow and $104.49 million in free cash flow on 1 April 2018. One has to wonder how this company is paying for its expansion. The cost of that expansion is high, Sprouts reported total debts of $502.80 million and total liabilities of $978.66 million on April 1, 2018.

The obvious conclusion here is that Sprouts is just one quarter away from the retail death spiral. All it would take is one bad quarter to cause collapse and acquisition at Sprouts.

 

Who Would Acquire Sprouts?

So who would acquire Sprouts anyway? The most likely candidate is Kroger which loves gobbling up troubled grocers.

Kroger bought Roundy’s right before collapse and has been feasting on the rotting carcass of Supervalu (NYSE: SVU). Kroger has been buying Supervalu stores in Virginia. Since Kroger has been purchasing high-end grocers like Harris Teeter and Marino’s and aggressively marketing organics, Sprouts would be a natural addition to the Kroger family.

Other potential buyers include the privately-held Safeway; which is backed by the Cerberus Group hedge fund, and Amazon. Sprouts would be a natural acquisition for Amazon which owns Whole Foods.

Non-American buyers for Sprouts include Lidil, which owns Trader Joe’s, and Aldi which is aggressively expanding its American footprint. Both German grocers are privately-owned deep discounters that emphasis quality foods, much like Sprouts.

One thing is certain, Sprouts would be a cheap acquisition for somebody, its shares were trading at $20.92 on June 19, 2018. Even though Sprouts would be a good acquisition for another grocer, it is a terrible stock to own. Investors should stay away from Sprouts because this grocer is on the fast track to over expansion and collapse.

There are better grocery deals out there including Kroger, Ocado, and Walmart (NYSE: WMT). All of which are in far better shape than Sprouts and well-positioned to cash in on delivery.