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Grocery Outlet and Sprouts: Wow! Factor Strong for GO, while Sprouts is Soft but Stable

Thomas Paulson
Nov 11, 2022
Grocery Outlet and Sprouts: Wow! Factor Strong for GO, while Sprouts is Soft but Stable

Specialty grocers Grocery Outlet and Sprouts Farmers Market increased their trailing-twelve-month (TTM) sales per square foot to $590 and $593, respectively, and the sales densities will continue to increase over the next two quarters given high food inflation (CPI food-at-home for October was +11% YoY). Importantly, Grocery Outlet is driving traffic and conversion rate higher, while in contrast, Sprouts’ traffic (excluding 3P delivery) continues to decline and its business mix is shifting from its core differentiator (produce). As such, Grocery Outlet’s growth and expansion strategy continues to be on strong footing, while Sprouts’ remains a "to be determined."

Key Grocery Outlet Metrics

  • Grocery Outlet 3Q22 results included a +15.4% comparable-store sales increase, which also reflects a robust improvement in the 2- and 3-year CAGRs (and well above industry levels, as shown in the table below). The comparable-store sales increase was driven by balanced contribution between transactions and ticket. Moreover, management’s 4Q22 outlook included a +12% increase in comps and their commentary on inventory, the supply of attractive product at great value, product innovation, and SKU expansion were encouraging.

  • At the national level, Grocery Outlet's monthly increases in traffic May through October have been relatively stable and in the +5%-6% range. Given that comparable transactions were up +7.9%, that suggests that conversion rate improved as well. An improving conversion rate implies that Grocery Outlet's guests liked the merchandise in the stores and bought with increased frequency; that affirms the management perspective on inventory and product innovation, etc.
  • When asked about regional trends, Grocery Outlet shared that the Mid-Atlantic produced the strongest growth. For the chain, the Mid-Atlantic is Pennsylvania (only 23 locations) and Placer shows that this region is producing some big increases from a lower base than the chain-wide average. The company's largest region--California--put up +4% traffic growth.

  • Grocery Outlet President RJ Sheedy provided an encouraging update on the company's progress to gain customer insights (a loyalty app) to deliver targeting messaging and upgrades to its financial, inventory, and operation IT systems.
  • In conjunction with its 3Q22 update, Grocery Outlet CEO Eric Linberg announced that he will be stepping down and that Sheedy would be ascending to the CEO role.
  • TTM sales per square foot increased $15 QoQ to $590. Given the breadth of strength and the traffic gains, it seems likely that comps and sales per square foot will increase by high-single-digits over the next year.
  • TTM EBITDA and free cash flow were $170M and $37M, respectively. Both metrics are likely to be up high-single-digits or better over the next twelve months.

Key Sprouts Metrics

  • Sprouts reported +2.4% comp-store sales which entail little improvement in the 2- and 3-year CAGRs, negative transactions, negative traffic, and a higher level of margin capture versus other grocers. Placer.ai data shows no improvement in its traffic trend intra-quarter. 4Q22 guidance of +2.0% also suggests that to be the case. Management shared that "traffic has been relatively stable for several quarters and that basket size was down by one item (customer buying two items versus three). Their view on traffic conflicts with Placer.ai data, as shown in the two charts below. We suspect one reason for the different view is that Placer.ai isn’t capturing the e-commerce/delivery component of Sprout’s business; that business is contributing 180 bps to comps. Separately, Sprouts’ produce business is lagging other categories (as revealed by the gross margin increase and management’s comments) which is concerning as produce is where the brand tries to differentiate itself from the competition.

  • Sprouts TTM sales per square foot increased $5 QoQ to $593. It seems likely to remain in that range over the next year. Seven new locations were added during the quarter (+16 for the year) and the plan is for 30 new locations in 2023 and 40 in 2024. Management also introduced a longer-term potential target of 1,350 locations (compared to 379 at present).
  • Sprouts’ YoY profitability rate was about even. Its gross margin rate is above 2019 levels, whereas SG&A expense per square foot is 3% below 2019’s levels. That contrasts to lower gross margin levels and higher SG&A levels (wage inflation) at most other grocers and retailers. This contrast gives rise to questions about the sustainability of Sprouts margin levels given the category’s competitive intensity and Sprout’s negative traffic trend. For comparison sake, Grocery Outlet's SG&A (excluding independent operator commissions) per square foot is up +14% compared to 2019. O’Reilly Auto Part’s SG&A per square foot is up a similar amount at +16%.
  • One of Sprout’s initiatives to secure customer loyalty is local sourcing; they have doubled the locally-sourced items YoY and is targeting 20% of sales by year-end 2024. Owned brands is another initiative and its owned-brands nonperishable sales grew at twice the rate of non-owned. On growing its loyalty program, 7.5% of transactions are to loyalty customers; the loyalty customer’s basket size is 70% larger than non-loyalty. 16% of transactions can now be tied to individual customers, up from 12% last fall (and better allowing for targeted e-mails). Another growth initiative is to push deeper into prepared meals and deli, and the commentary on those businesses was constructive.
  • TTM EBITDA and free cash flow were $393M and $280M, respectively, up substantially from last year’s $377M and $181M. Where they land one year from now is the big question.

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Thomas Paulson

Director of Research and Business Development, Placer.ai

Thomas Paulson spent 20 years as a Wall Street analyst and a member of asset management teams at AllianceBernstein and Cornerstone Capital, representing top-50 ownership positions including Target, Home Depot, Nike, Amazon, Google, and many more.

He brings consumer related expertise and knowledge of enterprises in retail, CPG, financial services, telecom, and entertainment.

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