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Company: Sprouts Farmers Market, Inc.

Exchange: NASDAQ.

Symbol: (NASDAQ:SFM)

Expected IPO date: 02 August, 2013.

Industry: specialty retailer.

The Offer:

Sprouts Farmers Market is offering 17,702,215 shares of its common stock, and the selling stockholders are offering an additional 797,785 shares of common stock. The anticipated initial public offering price per share will be between $14 and $16. The underwriters have an option to purchase a maximum of 2,775,000 additional shares from the company to cover any over-allotment of shares.

Valuations after current offering:

Shares to be outstanding after offering

143,658,944* shares

Offer price (mid range) per share

$15**

Valuations at $15** per share

$2.15 billion

*without over-allotments.

**The mid-point of the estimated range of the initial public offering price.

Summary:

Sprouts Farmers Market is a high-growth, differentiated, specialty retailer of natural and organic food focusing on health and wellness at great value. The company offers a complete shopping experience that includes:

  • Fresh produce
  • Bulk foods
  • Vitamins and supplements
  • Grocery
  • Meat and seafood
  • Bakery
  • Dairy
  • Frozen foods
  • Body care
  • Natural household items

Since the start of its business in 2002, the company has shown a rapid growth, organically as well as through the acquisitions.

The company operates 163 stores in eight states as of July 19, 2013, and is one of the largest specialty retailers of natural and organic food in the United States.

On average, its stores carry approximately 16,500 SKUs across all departments. It sources its products from over 900 vendors and suppliers, both domestically and internationally.

Store locations:

The diagram below shows its current store footprint, by state, as of July 19, 2013.

As of July 19, 2013, the company had 163 stores located in eight states, as shown in the table below:


(Click to enlarge)

Acquisitions:

Henry's Transaction:

In April 2011, the company partnered with the Apollo Funds, and added 43 stores by merging with Henry's and its Sun Harvest-brand stores. Its merger with Henry's brought the company to 103 total stores located in Arizona, California, Colorado and Texas as of the end of 2011.

Sunflower Transaction:

In May 2012, the company added another 37 stores through its acquisition of Sunflower and extended its footprint into New Mexico, Nevada, Oklahoma and Utah.

Growth strategy:

The company is pursuing a number of strategies designed to continue its growth and strong financial performance, including:

1. To expand its store base:

The company expects to continue to expand its store base with 19 openings planned for fiscal 2013, and approximately 20 store openings planned for fiscal 2014, and it intends to achieve 12% or more annual new store growth over at least the next five years.

2. To increase the comparable store sales.

3. To continue to enhance its operating margins.

4. To grow the Sprouts Farmers Market brand:

The company plans to continue to increase awareness of Sprouts as the value-oriented neighborhood grocery store destination for high-quality, natural and organic products. It will also continue to expand its innovative marketing and promotional strategy through print, digital and social media platforms, all of which promote its mission of "Healthy Living for Less."

Key Metrics: (operational) (Pro-forma: After giving the effect to the Sunflower Transaction.)

The key operational metrics includes:

  • The number of stores.
  • The comparable store sales growth.
  • The average store size.


(Click to enlarge)

The table below shows the average store size:


(Click to enlarge)

Industry Outlook (positive)

The company operates within the grocery store industry which encompasses store formats ranging from small grocery and convenience stores to large independent and chain supermarkets. According to the Progressive Grocer, U.S. supermarket sales totaled over $600 billion in 2012.

Sprouts is a high-growth, natural and organic food retailer offering a complete grocery shopping experience, catering to consumers' growing interest in living and eating healthier while offering consumers a compelling value relative to conventional supermarkets and mass retailers.

"According to the Nutrition Business Journal, sales of natural and organic food have grown at a CAGR of 12% from 1997 to 2011, reaching a total market size of $43 billion in the United States and are expected to continue to grow at a CAGR of 10% from 2011 to 2020. In addition, according to the Nutrition Business Journal, vitamin and supplement sales grew at a CAGR of 6% from 1997 to 2011, reaching a total market size of $30 billion in the United States. The Nutrition Business Journal forecasts this market will accelerate growth to a CAGR of 7% from 2011 to 2020." (Source: IPO prospectus, page 103.)

Financials:

(Pro-forma: After giving the effect to the Sunflower Transaction.)

Income statement analysis:


(Click to enlarge)

Key points from the income statement:

  • Its revenues grew by 15.5% from $1.72 billion in FY 2011 to $1.9 billion in FY 2012.
  • Its revenues grew by 16.25% from $493 million in Q1 FY 2012 to $573 million in Q1 FY 2013.
  • Its operating profit grew by above 150% from $33 million in FY 2011 to $85 million in FY 2012 (without considering one time amortization expenses).
  • Its operating margins show a steady rise during the last few years, from 1.9% in FY 2011 to 4.5% in FY 2012. (Excluding the impact of one time amortization expenses of about $32 million in FY 2011.)


(Click to enlarge)

Balance sheet analysis:


(Click to enlarge)

Key points from the balance sheet:

  • The inventory levels are about 5% of its revenues (FY 2012) (excellent operational metric).
  • The amounts receivable are about 0.5% (about 8 million) of its revenues (FY 2012) (excellent operational metric).

Key positives:

1. One of the largest players in industry.

2. Excellent operational metrics (discussed above).

3. Significant growth opportunities:

The company has significant growth opportunities in its existing and new markets across the United States.

"Based upon research conducted for us by Buxton Company, we believe that the U.S. market can support approximately 1,200 Sprouts Farmers Market stores operating under our current format. We believe we have significant growth opportunity in existing markets, as approximately 300 of these 1,200 potential stores are located in our current markets (eight states)." (Source: IPO prospectus, page 115.)

4. Successful integration of the acquired companies:

The company possesses the strong acquisition capabilities. Since 2011, it has successfully completed a couple of acquisitions to drive the growth. The table below shows its recent acquisition (Sunflower Farmers Markets, Inc. 37 stores) and the amount (in $ thousands) spent on the acquisition.


(Click to enlarge)

5. Excellent same store growth:

Stores under the company's management have achieved positive comparable store sales growth for 25 consecutive quarters, including throughout the recent economic downturn (from 2008 to 2010).

The company achieves a pro-forma comparable store sales growth of 9.7% in fiscal 2012 and 5.1% in fiscal 2011, and pro-forma comparable store sales growth of 8.0% for the thirteen weeks ended March 31, 2013 and 10.1% for the thirteen weeks ended April 1, 2012.

6. Well placed growth strategy (explained above).

7. Positive industry outlook (explained above).

Key negatives:

1. Seasonal:

Its business is subject to modest seasonality. Its average weekly sales fluctuate throughout the year and are typically highest in the first half of the fiscal year. Produce, which contributes approximately 25% of its net sales, is generally more available in the first six months of its fiscal year due to the timing of peak growing seasons.

2. Low operating margins:

Though its operating margin has shown a significant improvement in the last two years, but the margins (full year) are still are under 5%. (Explained above)

3. Pricing:

In connection with the sunflower transaction (effective May 29, 2012) the company's fair value per share was determined to be $6.01 per share, as compare to the offer price of $15 (current offering).

4. Acquisition based growth:

The company had shown a significant growth in its revenues and profits, but the most of the growth had come through acquisition. Since fiscal 2011 over 80% of its new stores come through acquisitions (93 out of 111). The company mostly depends on acquisitions for any exceptional growth, but acquisitions may not always come cheap and may not perform up to the expectation.

5. No manufacturing or processing facility:

The company does not have any manufacturing or processing facility.

Future assumptions: (These are just the assumptions, and the company may perform totally different from these assumptions)

The financial & the operational assumptions: (assuming that the company performs well in the future)

The assumptions are based on the company's performance of Q1 FY 13, Q1 FY 12 and FY 12.

Assuming that:

  • Its revenues grow by 16% in FY 13 and FY 14.
  • Operating margins are assumed to be 4.75% in FY 13 and 5.25% in FY 14.
  • Interest cost is considered as same, as in FY 2012.
  • Applicable tax rate is considered as 35%.

The table below shows the basis of assumptions:


(Click to enlarge)

The table below shows the financial assumptions:


(Click to enlarge)

Peer comparison: (for Offer evaluation.)

The company is a specialty retailer of natural and organic food. Whole Foods Market, Inc. (NASDAQ:WFM) is most comparable peer of the company, as both claims themselves as a retailer of natural and organic food and most importantly holds same growth opportunities.

The table below shows the comparison of both the companies:


(Click to enlarge)

(Source: Whole Food Market annual report 2012.)

From the above comparison, it's clear that Whole Food Market is available at comparatively better valuations, despite the fact that Whole Food Market is much bigger, its operational performance is much better and its balance sheet is exceptionally stronger than the company.

Valuation: (barring any unforeseen facts, and circumstances.)

At $15 per share the company is available at PE of about 70 (12 months ended March 31, 2013), which is expensive. These valuations only reflects the positive aspects (discussed above) of the company's business, and its exceptional past performance without considering the fact that it will be extremely hard for the company to repeat the past performance (acquisition based; explained above).

Even if one assumes that the company performs well (as assumed above) even then the company seems to be fully priced.

Conclusion:

In my view at these valuations one should avoid to enter the company. I do not find any solid fundamental reason that can support these valuations particularly when its peer which is considerably bigger and stronger, than the company, is available at comparatively much better valuations (explained above).

Net proceeds:

The company estimates that the proceeds to it from this offering, after deducting estimated underwriting discounts and commissions and offering expenses payable by the company, will be approximately $247.6 million, assuming the shares offered by the company are sold for $15 per share, the midpoint of the price range.

Use of proceeds

The company intends to use $247.6 million of the net proceeds from this offering to repay borrowings under the term loan portion of its credit facility.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Investments in stock markets carry significant risk, stock prices can rise or fall without any understandable or fundamental reasons. Enter only if one has the appetite to take risk and heart to withstand the volatile nature of the stock markets.

This article reflects the personal views of the author about the company and one must read offer prospectus and consult its financial adviser before making any decision.

Source: Sprouts Farmers Market: Whole Food Market Is Available At Comparatively Better Valuations