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Small Format Grocery: Learnings from Grocery Outlet & Sprouts

Thomas Paulson
Mar 10, 2023
Small Format Grocery: Learnings from Grocery Outlet & Sprouts

As expected, Grocery Outlet reported very robust +15% comparable-store sales on its Q4 2022 update and Sprouts Farmers Market reported a softer +2.9% increase. Both companies are seeking to accelerate openings of new locations and markets in 2023 and 2024. While Grocery Outlet’s opening pace is slower, its model looks more durable and the right offering for these economic times. Sprouts is losing customers and frequency of visit; while some of this is simply the high level of food-at-home inflation and other “macro" considerations. Other more company-specific, or micro-dynamics also appear at work, and Sprouts seems to not yet have its hands on a "silver bullet".

Grocery Outlet

  • Grocery Outlet produced comp-store sales of +15.1%, driven by a +10.0% increase in the number of transactions combined with a +4.6% increase in average transaction size.
  • RJ Sheedy, President and CEO of Grocery Outlet noted in the company's Q4 2022 update: "Our merchandise assortment is better than ever, our pipeline of opportunistic products is healthy, our marketing message of value and savings is resonating with a broad base of consumers, and our Independent Operators are connecting with customers in their stores and throughout their communities."
  • For 2023, Grocery Outlet intends to add around 26 locations to its base of 441 locations. However, CFO Howard Bracher is quoted saying, “We continue to expand our footprint despite construction challenges, and we expect the pace of openings to accelerate in the second half of the year to our 10% annualized new unit growth rate.“ (27 locations were added in 2022.) Sheedy added, “We believe we have the potential for more than 10x the number of stores we have today. We continue to manage short-term new store headwinds, which have delayed additional store openings… Our 3-year pipeline is healthy, and we expect to be back to our 10% annual new unit growth rate starting in the second half of this year (evenly split between the East and West Coast). Our plan for fiscal 2024 currently includes 47 new stores distributed more evenly throughout the year…We are also encouraged by early results in new states, such as Maryland and New Jersey, and we are excited to introduce the GO brand to many new communities.”
  • As shown in the figure below, visits to the New Jersey locations are near the California average--impressive given the Grocery Outlet brand is little known in the East.
  • 2023 EBITDA is expected to modestly grow on the back of +5% comp increases. Sheedy, “We remain focused on deepening our value, strengthening the treasure hunt shopping experience, elevating operator support, and increasing customer awareness, acquisition, and retention… We are pleased with the incremental sales from our SKU expansion over the past year. Key focus categories have been NOSH, fresh, ethnic, and local. Unique and differentiated private label products represent the next multiyear phase of everyday assortment enhancement. This year, we plan to add leadership talent to build the strategy and foundation for this new offering. Over the next several years, we plan to develop and introduce private-label items (currently in the low-single-digits)  that strengthen the value proposition for our customers while driving sales and profit. We also continue to further digitize our business with more integrated end-to-end technology. We have a successful history of modernizing systems to improve capabilities and drive efficiencies. This year's system upgrades include product, inventory, financial, and reporting platforms. These technology enhancements will provide new functionality and scalability to support key areas of our business, including purchasing, inventory management, and store operations. In addition, these systems will provide a strong foundation upon which we will develop future customer and operator-facing technology. One example is our personalization app, which is currently being piloted in Washington State. This new program extends the treasure hunt beyond the 4 walls of the store, and early feedback is positive. In addition to customer benefits, this app will generate robust shopping data to enhance our current marketing efforts and improve customer engagement over time. This year's technology upgrades will allow us to integrate more robust data analytics throughout our business. Future work will be aimed at improving data quality and integrating automated analytics to help with operations and efficiencies.”

Sprouts Farmers Market

  • For 2023, Sprouts expects to add 30 new locations and close 11 locations. The shuttered locations are larger in size (30% more than the current prototype at 23K sqaure feet, itself a smaller prototype than its predecessor) and a cash drain on the company. Additionally, Sprouts intends to withdraw from the markets where the 11 are located.
  • 2024 is expected to see nearly 40 new locations in that 23K square-fott prototype. Florida and the mid-Atlantic are focus regions.
  • For 2023, comps are not expected to improve with management guiding to a low-single-digit increase, inclusive of a +1.5-2.5% increase for Q1 2023. Despite the softer sales, profits are expected to be roughly even YoY. Capex is to nearly double reflecting a doubling of new store openings.
  • As shown in exhibit below, Sprout’s comps face headwinds from less traffic, fewer items in the basket, less weight/poundage, and trade-down within categories. Of note, Sprouts' transaction count is better than its footfall as 3P delivery service adds +200 bps to comps and potentially more to comp-traffic. Our read on CEO Jack Sinclair’s comments about winning new customers and driving per-household-spend higher was that they had yet to “find the silver bullet” for either.
  • We have previously shared that about 60% of Sprouts’ traffic decline is due to its losing its role as a secondary shop from a primary conventional grocer, club store, or discounter. The remaining loss of visits is from less affluent households that have switched to value / hard-discount grocers like Grocery Outlet, Food-4-Less, Aldi, etc.  Additionally and as shown in the table below, loyalty / shopper frequency did not substantially change this year vs. last for Grocery Outlet; whereas Sprouts lost frequency..
  • Curiously, Sprouts continues to drive its gross margin higher with retail prices increasing slightly ahead of costs. Additionally, they are aggressively repurchasing their stock. These actions suggest that management perceives Sprouts' market share and customer losses as transitory. We are less convinced of that given the current “heat” in grocery inflation and our more concerned outlook for less affluent households – the hourglass consumption pattern.
  • CEO Jack Sinclair shared, “Last quarter, we conducted a comprehensive research study to understand better what is most important to our customers post-pandemic. They consistently told us they are looking for us to help them take new measures to be healthy. freshness, quality, innovative variety, and commitment to sustainability are all key drivers for our customers. These learnings prompted us to pivot our marketing positioning to launch our new Find Your Health campaign in January. The campaign connects by sharing several ways customers can create their own health journey at Sprouts and is anchored by what customers tell us they love. Our fresh, high-quality and innovative products, you can't find anywhere else. This differentiates us and creates a sense of discovery for our customers. As I stated at the beginning of the call, Sprouts brand hit $1 billion in sales late last year, a remarkable accomplishment, largely due to our focus on innovation. We plan to accelerate this growth even more in 2023. You will see additional new Sprouts brand products and increased focus on seasonal programs and a brand style and packaging redesign that is already showing promising results. In 2022, we invested in growing our convenience meals and plan to double down again in 2023. We bring differentiation to this growing category with higher quality and healthier options. Our customers will find even more chef-driven creations in seasonal offerings, added plant-based and help attribute options and additional family meals. We doubled our local produce sales in 2022 with more than 11% of our produce sales now from local growers. We believe our relationships with farmers, scale and expertise in fresh produce enable us to own and grow this space.”

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Thomas Paulson

Director of Research and Business Development,

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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