Why Sprouts Needs to Grow and Grow Fast
- Sprouts will need a high level of continued growth to sustain its deep discounting business model.
- Sprouts has only 190 stores compared to direct competitor Kroger which has 2,460 supermarkets in the United States.
- Sprouts has a TTM revenue of $2.841 billion, Kroger has a TTM revenue of $106.48 billion and Costco has a TTM revenue of $114.49 billion.
- Costco’s sales of organic food in 2013 were $3 billion, larger than Sprouts TTM revenues.
Sprouts’ expansion plans could make it the nation’s dominant organic grocer.
Organic grocer Sprouts Farmers Market (NASDAQ: SFM) is in a very interesting and potentially dangerous position for a retailer: it needs to grow and grow fast. Sprouts will need to grow fast because it is going to need a lot of leverage just to stay in business.
Sprouts needs more leverage because its business model is to offer a lower priced alternative to Whole Foods Market (NASDAQ: WFM) for the middle and working class—not a bad business to be in at a time when average household incomes are stagnating and demand for organic food is growing by leaps and bounds. The Organic Trade Association reported that sales of organic products in the U.S. rose by 11.5% in 2013, according Bloomberg.
The root of this business model is old-fashioned deep discounting; Sprouts offered lower prices on 148 name brand items than Whole Foods. Sprouts’ prices on some produce items were 25% lower than Wal-Mart Stores Inc. (NYSE: WMT) and Kroger (NYSE: KR), the nation’s two largest grocers, Bloomberg reported.
Sprouts’ Weakness—Lack of Size
The danger for Sprouts is its lack of size—it operates around 190 stores in 10 states. Kroger operates 2,640 supermarkets and supercenters in 34 states in 2013. Wal-Mart operates 5,009 retail units; including 3,400 supercenters and 453 neighborhood markets, in the United States.
This means that Sprouts’ buying power or leverage is tiny when compared to those two giants. If either Kroger or Wal-Mart, both of which have a long history of deep-discounting, wants to start matching or undercutting Sprouts’ prices, they can.
In terms of revenue, Sprouts is at an even greater disadvantage. It reported a TTM revenue of $2.841 billion Sept. 30, 2014. Kroger reported a TTM revenue of $106.48 billion on Oct. 31, 2014. Wal-Mart reported a TTM revenue of $483.79 billion on Oct. 31, 2014. Another aggressive marketer of organic foods and the nation’s third largest retailer, Costco Wholesale (NASDAQ: COST), reported a TTM revenue of $114.49 billion on Nov. 30, 2014.
The Big Boys Enter the Organics Business
The giants certainly have the resources to crush an upstart like Sprouts if they wish, and they are interested in organics. Kroger was able to develop its natural foods private label, Simple Truth, into a $1 billion brand in less than two years. Costco now sells around $3 billion worth of organics a year, more than Sprouts’ total revenues, according to Bloomberg.
Wal-Mart has teamed up with Wild Oats, a well-known organic food brand name formerly used by a chain market acquired by Whole Foods in 2007. Wal-Mart now sells around 1,600 organic items but hasn’t revealed sales levels. It has been able to offer deep discounts on some organic products. Bloomberg reported that Wal-Mart was selling cans of Wild Oats organic black beans for 92¢, a comparable price to non-organic offerings.
The giants have entered Sprouts’ sector and are demonstrating that they can copy its deep-discounting business model. The question we need to ask is, can Sprouts keep up with them?
Sprouts Is Growing
The answer for the moment seems to be yes; Sprouts reported a year to year quarterly TTM revenue growth rate of 20.96% on Sept. 30, 2014. Its business is increasing dramatically when compared to far larger competitors. The increased competition in the organic sector has not affected Sprouts’ ability to generate more revenue.
Kroger reported a TTM revenue growth rate of 11.20% on Oct. 31, 2014. Whole Foods Market reported a TTM revenue growth rate of 9.41% on Sept. 30, 2014. Wal-Mart reported a TTM revenue growth rate of 2.86% on Oct. 31, 2014, and Costco reported a TTM revenue growth rate of 7.39% on the same date.
Sprouts is also engaged in an aggressive expansion; it plans to open 10 new stores in First Quarter 2015 and 10 in Second Quarter 2015, Progressive Grocer reported. If the expansion goes as planned, it will take Sprouts’ store count above 200 for the first time. The expansion will take Sprouts into two new states: Missouri and Tennessee.
Even with the expansion, Sprouts will still be smaller than Whole Foods, which operates 385 markets in the U.S. and 19 stores in Canada and the United Kingdom. Yet Sprouts has now grown to nearly half the size of Whole Foods.
Sprouts Wants to Build an Empire
Sprouts CEO Doug Sanders has even more ambitious expansion plans. Sanders told Bloomberg that he wants to increase its store count by 14% a year for the next 15 years. Sanders thinks that level of growth could take his company’s store count to around 1,500, which would give it leverage rivaling Kroger.
To achieve that level of growth, Sprouts would presumably have to pass Whole Foods’ store count at some time in the next few years, making Sprouts the dominant organic grocer. It would also make itself a serious rival to Kroger and Wal-Mart, which would presumably strike back with really deep discounting.
Growth Is Key to Sprouts’ Survival
Such aggressive growth might be the only way that Sprouts can survive in the grocery industry. The only way Sprouts would be able to compete with Kroger, Costco and Wal-Mart in deep discounting is to match their wholesale buying power and distribution networks.
Deep discounting alone may not help Sprouts, because Kroger, Wal-Mart and Costco offer customers amenities the organic grocer lacks. Kroger has filling stations at 1,293 of its supermarkets and pharmacies in around 1,948 of its locations. Walmart has pharmacies in its 3,400 supermarkets and fuel centers at many of them. Costco also offers gas stations and pharmacies at most of its stores.
In addition to fuel and pharmacies, both Kroger and Wal-Mart are developing new capabilities that Sprouts will have a hard time duplicating. Both retail giants are experimenting with online ordering, including delivery options and Click N’ Pull. Kroger is also a major player in digital coupons; it reportedly made 400 million digital coupon downloads in 2013. Wal-Mart has plans to invest up to $1.5 billion in ecommerce and digital marketing by 2016.
If it wants to play in the Big Leagues with Kroger, Wal-Mart and Costco, Sprouts is going to need to generate a vast amount of revenue because it may need to start offering the kinds of amenities those stores have. Sprouts may also have to start duplicating competitors’ digital capability. That will take a lot of money—the kind of revenue generated by 1,500 grocery stores.
The only way Sprouts might be able to survive is to try to carry out Mr. Sanders’ ambitious plans and grow fast. If it loses momentum at any point, Sprouts could die and collapse almost overnight. Growth, it seems, is the key to Sprouts’ survival and perhaps the only strategy open to it.
Disclosure: the author holds shares of Kroger.