Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

Will Sprouts Survive?

I ask will Sprouts survive because the discount grocer is expanding aggressively in an increasingly competitive grocery market.

For instance, Sprouts Farmers Market (NASDAQ: SFM); Co-CEO Bradley S. Lukow, tells analysts most of the new stores the company plans are in new markets, Food Business News reports. In fact, Sprouts now operates in 19 American states.

For example, Sprouts is expanding into its first Northeastern State; Pennsylvania. Moreover, Sprouts could soon enter the savagely competitive New York City grocery market by entering New Jersey.

Specifically, Sprouts; which currently operates over 300 stores, plans to open 28 stores next year. Additionally, Sprouts will compound the risks by opening eight new concept stores, Food Business News reports.

The Growing Threats to Sprouts

Sprouts’ survival is in doubt because it keeps expanding in brutal grocery markets full of dangerous competitors.

Just a few of the competitors Sprouts is challenging head on include:

  • America’s largest standalone grocer Kroger (NYSE: KR). Sprouts is competing directly against Kroger’s Harris Teeter brand in the South and Mid-Atlantic. In particular, Kroger’s Simple Truth natural and organic brand delivered $2 billion in sales in 2017, Progressive Grocer reports. Plus Kroger is increasing its capabilities with massive investments in digital and robotic fulfillment centers designed by the Ocado Group PLC (LSE: OCDO).
  • Aldi or Aldi Sud. This fast-growing German discount grocer threatens Sprouts by focusing on quality and selling at extremely low prices. Aldi; which now operates over 1,800 stores in 35 states and plans to open another 400, is making a push into organics. In particular, Aldi plans to go fully organic by selling pesticide-free foods, Educate, Inspire, Change claims.

  • Lidl. Aldi’s main competitor enjoyed 8.8% growth with its European operations and sales of €104.3 billion ($117.4 billion) in 2018, Reuters reports. Lidl is using some of that money to expand its American operations. For example, Lidl plans to open 25 new stores on the East Coast over the next year, The Baltimore Sun reports. Many of those stores will be in areas where Sprouts is expanding. In addition, Lidl is buying locations from older less competitive grocers.
  • Trader Joe’s. This discount grocer with a cult-like following is Sprouts closest direct competitor. Like its parent Aldi Nord, Joe’s keeps prices low by offering over 80% private label products. Moreover, Joe’s targets the same middle-class foodies that Sprouts does but has a higher profile and lower operating costs. In addition, Joe’s has a secret weapon in the form of a legendary wine, beer, and liquor department. More importantly, Trader Joe’s has the money and power of Aldi Nord and Lidl behind it. Finally, Trader Joe’s is expanding carefully opening four new stores on the East Coast in Spring 2019.
  • Amazon/Whole Foods. Back in June 2017, what should have been a major victory for Sprouts turned into a nightmare. To explain, Whole Foods collapsed because of over-expansion prompting its management to sell out to Amazon (NASDAQ: AMZN) for $13.4 billion. Predictably, Amazon is lowering Whole Food’s prices and slowly integrating with its online retail platform. Dangerous developments for Sprouts include Amazon’s slow but steady rollout of same-day Prime grocery delivery. Also problematic could be Amazon Go, Amazon’s potentially low-cost automated grocery and convenience store concept.
  • Walmart (NYSE: WMT). America’s grocer’s efforts in organic and natural foods have been tepid. However, Walmart owns a 26% share of the US grocery market, The Motley Fool’s Adam Levy estimates. In addition, Walmart is making a big push into coastal urban and suburban markets; probably to offset declining incomes in its home turf in the heartland. Moreover, Walmart is making large investments in grocery technology. For example, Walmart is testing the use of artificial intelligence to monitor stock levels and customer behavior at a Neighborhood Market in Levitown, New York.

Can Sprouts Survive the Grocery Wars?

Thus, the already savage grocery wars are heating up, as dangerous competitors deploy new weapons and enter new markets. Therefore, Sprouts’ survival is in serious doubt.

Sprouts’ (NASDAQ: SFM) resources are puny in comparison with competitors. For instance, Sprouts records quarterly revenues of $1.431 billion and a gross profit of $484.35 million on 31 March 2019. Meanwhile, Kroger had $28.91 billion in quarterly revenues and a gross profit of $6.188 billion on the same day.

Amazon reported quarterly revenues of $59.7 billion and a gross profit of $25.78 billion on 31 March 2019. Finally, Walmart dominates with quarterly revenues of $138.793 billion and a quarterly gross profit of $$33.886 billion on 31 January 2019.

Worst of all, Sprouts had just $19.5 million in cash and equivalents and no short-term investments on 31 March 2019. Consequently, I think Sprouts has no resources and could collapse.

Is Sprouts Making Money?

I believe Sprouts will collapse because it makes almost no money. For instance, Sprouts reports an operating income of $79.56 million and a net income of $56.39 million on 31 March 2019.

Additionally, Sprouts had an anemic operating cash flow of $112.61 million and a free cash flow of $82.46 million on the same day. Under these circumstances, Sprouts could run out of cash.

Will Amazon or Kroger Buy Sprouts?

The most likely outcome of this scenario is that Sprouts will follow in Whole Foods’ footsteps. To elaborate, Sprouts will run out of money and get sold.

Likely, buyers for Sprouts include Amazon; which is reportedly shopping for more grocery chains, Aldi Nord, and Kroger. In particular, I think Sprouts could be a good fit for Aldi Nord’s stable of discounters; which includes Trader Joe’s and Lidl. Moreover, Aldi Nord is expanding its American footprint with 28 new Lidls on the drawing board.

Finally, Sprouts will be cheap, it had a share price of $20.45and a Market Cap of $2.415 billion on 23 May 2019. Consequently, I think Sprouts could be an acquisition target despite its aggressive expansion. For instance, Whole Foods was expanding aggressively right up until the Amazon sale.

However, I advise investors to stay away from Sprouts because it pays no dividend. Instead, if you want a cheap grocer buy Kroger because it is larger and more secure. In fact, Kroger had a $23.53 share price on 23 May 2019 but it will pay a 14₵ dividend on 1 June 2019.

In the final analysis, I think Sprouts will survive as part of a larger grocer. However, I believe Sprouts is unsustainable as an interdependent grocer in today’s brutal grocery market.

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