Sprouts Farmers Market, Inc. (SFM) Earnings Call Transcript & Summary

All right. Another exciting session for you all. So thanks for hanging with us here in the Crystal Room. Again, I'm Jack Cassel with Nasdaq, and I'm excited to welcome 2 key executives here coming all the way over from Arizona to join us, Jack Sinclair, CEO. and Curtis Valentine, CFO of Sprouts Farmers Market. So maybe just to level set for the audience, we'll start with an overview of Sprouts, and then we can kind of get into some of the differentiators from there.

Yes. Well, Sprouts Farmers Market, we've got 440 stores across 24 states in the United States. We focus on the natural and organic sector. And that's a narrow sector of the total U.S. food industry, which might be $1.4 trillion, $1.5 trillion. We're focusing in on $200 billion. We're a $7.5 billion retail sales revenue, market cap of about $13 billion, $14 billion, something like that. And the focus of the business is very much about that target customer that's natural and organic and everything that we're doing, whether it be marketing, merchandising, operations, supply chain is focused on servicing that customer. And a big part of that is creating differentiated products and we don't like to be described as a grocer. We like to be described as a specialist retailer because our business is very different. And that focus we're building stores about -- we built 35 stores this year, hopefully, a similar number and a bit more next year. We're aspiring to get to 10% growth. Every time we build more stores, the 10% number goes up. So we're chasing that opportunity, but we believe there's an opportunity for 1,200 stores across the United States where there's catchment areas that fit well with our target customers. So that's kind of a brief overview of where we're at.

Yes. Well done. Well as a consumer, one thing that I've noticed, and I believe is part of the strategy is the store layout. So maybe you can speak to that as part of the strategy and some of the other kind of niche focus.

Yes. One of the key differentiators for us is low-profile stores. So when you walk into the store, you can see all the way across the store. Our stores are -- in average, we're about 28,000. We're bringing the store size down to 23,000, and that's the stores that we're building going forward. Produce, unusually for a food retailer, we've got grocery -- our produce is at the back of the store. We start the store with meat, and you can see all the way around the store from when you walk into the store, and that's a big part of the operation. Having bulk foods in our store, we're the largest retailer of bulk foods in the United States. And we've got -- so we sell a big proportion of that, which fits well to the conscious consumer who's thinking about using less packaging and portion control. We've got a very important part of the business, the vitamins and supplements area, which is about 8%, 9% of our sales, where this principle of food as medicine as food being med and not being drugs where people go to use medicine -- use vitamins to improve their well-being, and that's a big part of this health and well-being initiative. And those target customers that I talked about, the navigation around the store supports those target customers, and that's very much the uniqueness of our format.

Could you talk about the drivers of your strong sales performance as well as what's been driving your margins?

You want to talk about sales?

Yes. On the sales side, I think it's a series of initiatives we've really put in place along with that strategy. So we've been working really hard on our customer service. We've reintroduced sampling for the customer, introducing them to our products. We've worked really hard on our inventory management so that our in-stocks are significantly improved from where they were. And then throughout the change in strategy, it's been about the assortment and really targeting that target customer with a unique assortment that's bespoke to them. And so as we put these things in place over the last few years, we've really seen a nice build in our comp. It started in Q1 of 2022 and it's culminated here this year where went 4 in Q1 and then close to 7 in Q2 and then an 8 in Q3. And so those things have just continued to improve, and they're all kind of landing a little bit. Meanwhile, we know that there's some tailwinds from the world around us, too. I think certainly, this movement towards healthy living and health and wellness is pushing customers our way. And I think in the states, the folks are moving out of restaurant a little bit as the budgets get a little tighter and they're moving back into grocery, and that's supporting us a little bit as well. So what we've been really pleased with here through the middle of the year is our marketing efforts, driving a lot of folks through, particularly in social media. And so we've seen our brick-and-mortar traffic really improve. And then as these new stores we've opened have come online, we've seen a lot of comp benefit from them. So that's really driven that acceleration we've seen through 2024.

So I'll just reinforce the marketing message a little bit. The evolution in our marketing from a few years ago was when we were sending 21 million paper flyers out to a lot of customers who weren't relevant to our target customers and promoted. So moving on to the margin thing. That was all about investing very aggressively in promotions, $10 per dollar corn, half-priced chicken fillets. And that was driving customers in who weren't in that target customer space. And that was creating a margin dilution. And actually, when you run out doing that year after year, it affects your sales as well. So we were deflating our sales and creating a problem with our margins. Marketing has evolved, as Curtis said, to be much more directive and much more thoughtful about it without paper. From a margin point of view, not doing the promotions was a big improvement in how we had a step change in the margin play that we're at. From there, the operations side of our business has been -- has evolved really well. I'm really proud of the teams in the stores running the stores. Shrink, which is operating efficiently around inventory for us as opposed to Shrink that you hear from a lot of other retailers are about Shrink being people stealing from you and organized crime. Our business is about managing that fresh inventory really effectively, fresh produce, the deli department, and we're seeing real improvements in our margin from operational efficiency through Shrink. So we're encouraged by that. And our category management work, we're bringing a lot of new products in. Those new products are helping enhance our margins as well. So the combination of product, combination of Shrink and the combination of being more effective in our marketing and less promotionally focused has really been the big driver of our margin improvement.

And then maybe you touched upon one piece there just around kind of the vendors and you have this thing, the foraging team as I think it's about 2 years old now. And so maybe you can share a little bit about the foraging team and how that's really improved kind of that go-to-market?

Yes. We're very excited. We've got a Chief Foraging Officer, which is a great name, and we're very excited about the work that, that team is doing. And their job is to go find things that support that target customer. Go find differentiated products that fit in the attributes that tie up with health enthusiasts, whether it be vegan, vegetarian, keto, paleo, gluten-free, dairy-free, that whole dynamic, finding innovative products that play into the food is -- contributes to health. And that team of people, they go to lots of shows around the world in terms of looking at. They have pitch slams where teams some of the entrepreneurial skill in the U.S. comes to that team and does gets -- almost like speed dating gets like a 20-minute chance to pitch their product to us, and we're doing that very regularly. And we're constantly looking at the social, what's happening online, what's the dialogue online and what opportunities are there. When we look at the market that's operating in the Internet, what are these D2C things happening that could be of opportunity for us going forward. Constantly, we put in place an innovation center in our store that if it's being sold anywhere, it's not allowed to be in that innovation center. So that -- this moving away from selling the same things as other grocers in the marketplace to selling differentiated products. That's what the foraging team have been about. And underneath that foraging team, we've got a private brand team who are working for -- not the way you would traditionally think about private brand where you bring a product in that copies a branded product, sell it a bit cheaper, good quality and make more margin. Our play is not in that commodity space. It's very much about finding products that fit the attributes and differentiate us. Part of that in the last couple of years, we've moved from 16% sales in Sprouts brand to 23% sales in Sprouts brand. And we've got no set objective to make it higher, but it will be how good the team are at bringing products that work for the customer.

Love that. You spoke to innovation and kind of tracking what's on the Internet. Can we maybe pivot to e-commerce and how that strategy is starting to play out. Maybe we can touch upon Uber Eats and that recent partnership.

Yes. So pre-pandemic, 2% to 3% of our business done through e-com, and obviously, that changed with the pandemic. And so we've had a great partner in Instacart all the way through, and we moved quickly to roll out pickup with them. Our business is a little different than the traditional. It's about 80% delivery, 20% pickup versus most traditional grocers will be flipped. Because once you get to our store, you've done the hard work and you kind of want to go in and experience the format. And so we've gone on then to add DoorDash first in late 2022, and then we added Uber Eats in late 2023 and really have seen all 3 partners have been great, great partners to us. I think they really enjoy what we do with our target customer. We've already kind of curated on their behalf. They're going after that same healthy customer that we have already. All 3 are growing ahead of our total company growth. All 3 are contributing to our comp growth kind of consistently and equally. And so we're really pleased with what they've done for us and that it provides access to our customer and becomes a convenience for our customer who maybe lives too far away from a Sprouts to get to on a regular basis that can now access our assortment through one of those partners online. So we've been really pleased with how that's played out and what it's doing for us.

And we're pretty confident that we've got an omnichannel customer. We've not got an online customer and a bricks-and-mortar customer, we've got a customer that spreads across that omnichannel. And the confidence that we have on that is we sell as much produce online as a percent to the basket as we do inside our store. That's pretty unusual for a food retailer to have produce where -- so the trust that the customer has, I think, has come from being in store in the first place. So we're constantly looking at what is our omnichannel customer and how does it work? We wouldn't be getting the success in our e-com business, which has gone from 2% to 14% of our sales. If the customer wasn't recognizing, you might as well go anywhere to buy online grocery if it's all the same. But the fact that we've got that differentiated assortment, and we believe that the work that we've put in place is kind of validated by the mix that we're getting on e-com. And as Curtis said, our partners have done a really nice job supporting us.

I love that. Can you share a bit about your unit growth?

Store growth?

Yes.

Yes. So that's been a piece we kind of -- we want to be growing 10% units a year. We've been chasing that a little bit. When we changed the strategy, we had to pause for a bit, get the format right and then start again with that new format. And so we opened 12 in 2021. We're up 16 the year later, 30 in 2023. And then this year, we've opened 33 and then we've relocated a couple of stores. And we're going to continue to go north from there. So it's been 8% the last couple of years. Next year, we'll do at least 35, and then we're on a journey back to that 10%. We need to get a little bit more efficient in our opening time lines. We have more than 100 signed off internally, and we've got more than 70 leases signed. So there's plenty of sites available. It's just about really going a little bit faster with the process. We can just a little help with the interest rates, too, to speed up some of the development cycles. But we're on our way back to that 10% growth for the long term. Things are working really well for us right now. We're seeing really good growth, particularly in areas like Florida, where we've put a lot of stores in the last few years in a newer market for us. So we're excited to get out to more and more communities as fast as we can.

And the limitation on store growth in the short term is that we want to be within 250 miles of a distribution center. One of the key parts of the strategy, if you want to be good at fresh produce is not distributed. You get short in the lines of distribution, which saves money in terms of gas and getting the miles you have to travel. We've taken 1 million miles off the road in terms of what we've done with some new DCs. But the store growth program is based on finding these stores that fit in with the target customer within 250 miles of a distribution center. We'll need more distribution centers in the future to keep operating in the Midwest to get us to operate in the Northeast, and that's part of the investment in programs going forward.

Okay. And can you share a bit on your perspective of CapEx as it relates to kind of present day, but also continuing to scale?

Yes. So from a model perspective, long term, 3.5% of sales is kind of what we're aiming for CapEx-wise. And that's more than enough to fund. It's largely coming from new stores, a little bit over half of it will come from new stores. We've got to keep the stores that we have fresh and clean and maintained. That will be another 20% of it. And then we've got a little bit of room for strategic initiatives and to drive sales in the business. So that's the kind of algorithm, so to speak, 3.5% of sales. That will also have room for the DC expansions that Jack mentioned. So we'll need to add a few DCs along the way, and that should all fit within that 3.5% of sales.

Okay. And then sticking with supply chain, you mentioned the DCs. Are there other elements of the supply chain just kind of closer to producers, I guess? Or how does that algorithm look?

Well, yes, we only control our distribution centers, control our produce business, which is just north of 20% of our sales. Working with each distribution center works locally with the growers. Certain markets, there's seasonal times where local sourcing is really, really important. So Colorado, there's a short window when it's very important. We've got to get it right. Florida, there's a shorter -- a longer but short window where Florida works. We've got individual DCs have their own produce sourcing teams who work locally with the farming community and the growers to give longer-term commitments. We're very aggressively trying to source more and more organic produce, giving commitments locally to farmers who will commit. We'll commit to take their field 2 or 3 years down the line. They'll know what the cost inputs are going to be. We can manage the whole supply chain in terms of when we get it, the price we pay. And that price should be lower than it would have been, but they'd make more money because the planning down it. So it's a kind of tripartite thing where the customer benefits, we benefit and the farmer benefits. And that's very much the model that we're working to across the supply chain on produce. Outside of produce, we sell -- we've got capacity now in our new distribution networks. We built a new one in Colorado, a new one in Florida. We built an expansion to our -- we built a new one in Southern California and expansion in Texas. That will allow us to do more than produce in the future, and we're working our way through how to do that, but we'll add more fresh. There's capacity for us to add fresh foods, a lot more fresh foods, and that will allow us to work even more closely with the vendor base to develop further upstream the ways of making this fresh food sourcing more specific. And outside of that, we work very closely on our ambient business with an organization called KeHE, who help us manage the very long tail that exists in the natural and organic space. So there's a lot going on in distribution going forward. All of it is about how do we get ourselves into a long-term sustainable play and get in stock where we need to get across the board.

Okay. There's a new opportunity. You recently launched -- or I believe you launched the loyalty program or maybe it's still in beta form. But maybe you could share a little bit on the outlook for that program and how some of the early data is reading for that.

Well, for us, it's very much about personalization and customer engagement, right, at the forefront of it. So the loyalty piece will be the engine for us to acquire data from our customers that will allow us to then, in turn, use that data to help them live and eat better and stimulate demand within our stores. We're out in a test in 2 markets: Tucson, Arizona, Nashville, Tennessee. One of those is a more established market that's been around a little longer, one of them a little bit newer in Nashville. So it should give us good insight into our mix of stores. But the idea is, again, create a community within our target customers, something a little bit different. It won't be the traditional transactional. I give the card, I scan, I get something, I get a different price. I don't know what I've saved or why, but I do it reflexively. It should be a little bit more bespoke to who we are and our customer -- our target customer focused on our innovation, focused on our products, focused on how they engage with us in their unique way. So we're testing right now. We've just -- in this week, I think we're rolling out to 3 more markets to just expand the test to get a little bit more data about how that's working. Our early results are good, and we're excited to continue to expand that out. We'll start a full chain rollout the middle of next year. We've got some work to do on the technology to make sure we're ready to go there. But we'll get all that done in the first half of 2025, should be rolled out by the end of 2025 with a kind of a staggered rollout through the second half of the year.

Okay. Great. I do want to pause here to see if there's any questions from the audience. We've got one here on the other, if you can see how you got...

Just a 2-parter. First part, could you talk about RFK and potential impact from him? And secondly, are you using any regenerative farmers, any farmers using that type of business model?

Sure. RFK has got some very interesting points of view that to be quite honest with you, we would -- on the specifics of what the food industry is and what it can do. I think there's some parallels in how we're thinking about where we play in the food industry. I've got no idea how that will work its way through the political dynamic of that. But on that particular issue, we're kind of in tune with much of what he says, and he's not the only one saying those kind of things. So he's certainly part of a movement that's beginning to challenge the way food is produced and how it's sold in the United States. So that's something that I'm not sure we're going to be directly -- it's directly relevant to what he does, but we'll see in due course when things emerge next year. Regenerative agriculture has become a really important part of the work that our team are doing in the produce department, in particular, how to create regenerative space. We did a big promotion with an end cap of all regenerative products very recently. It's about expanding that and understanding how we can get -- it's really trying to get much more circular in how the whole system works. And we're excited about it. It's early stages for our business. I think it's early stages for regenerative generally, but we should be at the leading edge of that, and we will be going forward.

One and then one in the back. Coming to you.

Can you say a little bit about when you open a store, how long does it take to get up and running? How long is it before it becomes profitable?

Yes. Our box economics, about $3.8 million is the cost to build. Year 1, they'll come out at about 75% of maturity. So for us, that's about $13 million a year or $250,000 a week, roughly breakeven EBITDA-wise in year 1. And then it will take about 4 to 5 years for 30% to 35% cash-on-cash return. So profitable in year 2 and then 30% to 35% cash-on-cash return by year 5 is the general period. More established market, it will be a little quicker, a market where we're a little newer, a little less awareness will take a little bit longer, but we're seeing that play out with the new stores we've built the last few years.

Yes. I really like the clear focus you seem to have on your customers. And the way you describe them, it sounds like they're sort of very health conscious and also sort of -- yes, really conscious about health and governance and that kind of stuff. At the same time, you are a commercial company trying to make a profit. Is there a -- is that a problem? Or how can you exploit that opportunity?

I honestly think it's the opposite. I think it's an opportunity. I think it's something that we can do good by doing good. There's a purpose to our company called -- which we talk about, which is about live and eat better. And if we can do a really good job at helping our target customers live and eat better, we can generate very substantial returns for our commercial operation going forward. So it brings the 2 together. One of the things I've been really pleased about is that the team members, we've got 33,000 team members across the country are buying into that purpose. And they feel that if they perform, they're doing more than just earning a good return and good bonuses and all the things that happens. They feel that they're contributing to making the world a better place. I know it sounds a little bit -- kind of hyperbowl. But if you can -- if you feel you're part of something that's making a difference, it really does inspire to do better. And if you do better, you'll perform better, your sales get better, you make more money, you won't throw -- Shrinks are a really good example of making the world a better place. Let's not throw things away if we can. And we've got 400-odd stores with people working on that. The better they are ordering, the better they are at flowing it through, very specific things that can contribute to a bottom line because you've got a purpose that ties back to this, how do people live and eat better. It's something that we've been really pleased with the way the reaction to people that come and join us. They're joining for a purpose as well as joining for a salary, and that contributes to the performance, I think, of our business. And again, from a long-term perspective, there will be more people interested in this in 5 years' time than was interested in it 5 years ago. There's more people today than 5 years ago. Just generally, people are getting more interested in what they eat. They're more interested in the -- in how the food is being produced, what's in the food, more interested in the animals, in the livestock supply chain, more interested in the people, the soil, the water, that conscious consumer. And we're aligning the conscious consumer, the target consumer with the team member. And I do believe that if you get the team member right, the customer right, the shareholders will come right as well. It's a kind of tripartite thing that can come together, and we're very excited about the opportunity.

Great. Any other questions from the -- well, maybe we'll just part with one last one. Actually, it's a 2-parter so. One is for the audience, what is maybe one thing that you could be misunderstood around your investment thesis thus far that we want to make sure they hear? And then two, is there a favorite item in the store for both of you?

I'll let you do the favorite item, Curtis. The biggest challenge we've had, Curtis and I in talking to the investment community is we're not a grocer because this thesis is your margins go up and the competitive dynamic pulls you back down again. If you're selling things that other people don't sell, you don't have that pressure. It almost doesn't matter what happens when the competitive space, the grocers start beating each other up about the price of Coca-Cola. It doesn't really matter to us as long as we've got the great probiotic soda in there, it's a good -- and we can check the value of that and make sure it's working for us. So the biggest -- and I think we're making some progress on this. The biggest thing is we can grow our top line and our bottom line independent of what's happening in the great mass of the grocery space. Remember, there's $1.4 trillion in this space. We're only going after $200 billion. They can fight over the $1.2 trillion that we're not chasing after, and we can be very successful irrespective of what happens. During 2020, early in the pandemic, Kroger and people that were running 15% comp, and we were only running 7% and people are saying, well, what's happening here? Now we're running a lot higher than them and people are saying, oh, what's happening here? Quite frankly, we can perform whether Kroger are at 2% or 15%, and we'll perform really well. So that's the dynamic, I think, that I need to get hopefully working our way through with the investment community. And we can only do that by performing, and that's what we've been trying to do.

And I'll talk about eating food. So that's great. One Pan Meals, that's my favorite product. We have these meals to go, ready to go. They're in a little recyclable aluminum tin, pop the top off, throw it in the oven, 20 minutes later, it's fresh. It's not precooked. It's fresh. Fresh food is usually a meat and a vegetable, a little marinade, perfect. My wife works, I work, we're busy. Having a few of those in the house makes dinner easy, and we feel like we're eating pretty well still and not running through a drive-thru moving further from living and eating better. So that's my favorite product.

Love it. Well, thank you both for the time, Jack, Curtis. This was very educational and appreciate it.

Thanks, Jack. Thank you.

Thank you very much.