A New Vision for Sprouts

Riding high on near-term sales and profit growth helped along by the COVID-19 pandemic, Sprouts Farmers Market this week formalized a long-term growth strategy its officials said could also be accelerated by consumer behavior changes undertaken in the crisis.

In a presentation while reviewing the chain’s fourth-quarter earnings, CEO Jack Sinclair and new Chief Financial Officer Denise Paulonis described a vision for Sprouts, calling for smaller and more densely located stores with fewer self-serve food stations but more innovation and discovery inside; a drawback of traditional commodity price promotions in favor of targeted digital marketing and an emphasis on everyday values; foregoing bargain-driven shoppers for those truly interested in healthy lifestyles and food discovery; and support through a lower-cost supply chain.

Sinclair, who arrived at the Phoenix-based natural foods chain last summer, had made no secret of his intentions to make changes at the company—moves some have described as a vision for a health-focused Trader Joe’s—and would likely have prescribed the same measures absent of the national health crisis. But he acknowledged “significant changes in consumer behavior” brought about in recent weeks—not to mention loads of new customers Sprouts has encountered as alternative venues shut down—as points of support for the new strategy.

“Though we are keenly focused on the present, COVID-19 has provided us the opportunity to create trial and awareness of our brand as well as capture new customer emails and recruit more customers to our app to establish longer-term loyalty,” Sinclair said in a conference call, according to a Sentieo transcript. “Currently, we have paused many of our print ads as they are less relevant during these times. We've adapted our marketing spend to focus on customer acquisition and communication through more digital, social and streaming radio with the message to stay connected with us."

“Anecdotally, we've heard from many customers in our new markets that it was their first visit into our store as they were unaware of us before the crisis,” he added. “The changing dynamics during this health crisis has prompted consumers to opt for healthier food, resulting in a mix increase to more organic sales and produce and more grass-fed beef and more antibiotic-free chicken.”

Changes In Store

Sprouts’ “enhanced prototype” stores—a signature of the company's previous administration meant to capitalize on consumer desire for meals on the go behind large delis and a larger, 30,000-square-foot size—will no longer be pursued, Sinclair said. Instead, Sprouts will return to boxes of 21,000 to 25,000 square feet that Paulonis said are cheaper to build—about $3.2 million vs. more than $4 million for the larger units—and will be more productive.

The tighter footprint will likely accompany a reduction in the size of the deli, fixtures for self-serve soups, salads and olives, and a tighter layout for departments such as vitamins and supplements while emphasizing sections where Sprouts can differentiate: produce, frozen foods, center-plate proteins and discovery.

“If anything, COVID-19 gave us a glimpse into what this [new store] may look like,” Sinclair said. “It highlighted that simplified, premade items like salads sell, and more complex, costly salad bars may not be necessary in future models. As well, it has allowed us to see clearly where we could gain SKU optimization.”

Sinclair described making room in future store models for an “innovation center,” where vendors can highlight new products and incubator brands can display what is new and trending.

“Looking back, we had higher expectations of the enhanced larger box we have been building,” Sinclair said. “And though it is an appealing box, these stores struggled to provide more favorable economic returns to cover the increased capital costs. And yet, we had a great model in our older vintages that were less costly to build and, therefore, a better fit for our ongoing rapid expansion.”

Sprouts said its plans call for 10% annual unit growth—that would be more than 30 stores a year, based on its current 344-store fleet—and a blueprint calling for first-year sales of $14 million each, with sales gradually growing to 20% to 25% over four years to annual volumes of $16 million to $18 million. An approximate 20% reduction in the cost to build them would result in superior returns of 40% over that four-year period, Paulonis said.

Sprouts will concentrate that store growth in geographies where an enhanced supply chain can more efficiently deliver goods to them, officials said. That means stores within 250 miles of fresh distribution hubs. Sinclair said the company had plans for two such facilities in Florida and in Colorado to support growth in those markets, along with places in Texas and California that are already in easy reach of fresh distribution centers. Sprouts included mid-Atlantic states as a growth area but said plans were still in the works for facilities to support them there. This plan would significantly reduce transportation costs.

Paulonis said Sprouts would “evaluate” stores in markets that would fall out of the tighter radius. This presumably could include a smattering of stores in Pacific Northwest and in some Midwest markets.

Significant Headroom With Target Shoppers

Central to Sinclair’s vision is capturing a greater percentage of shoppers motivated in their food choices by health, natural and organic products, and discovery, and the company is prepared to sacrifice less profitable shoppers who historically have shopped Sprouts primarily for price deals on fresh food.

Sinclair said customer research indicated Sprouts “overindexed” on health enthusiasts and innovation seekers, “and this is where our future path will be focused."

“Though these customers look for better-for-you options and innovative products to support their healthy lifestyle, we found we had significant headroom with these target groups to capture new customers by doubling down our efforts,” he continued. “We can double our business by capturing just an additional 3% with our target customers. We should be the destination for healthier food.”

These insights have accompanied a pivot in promotional strategy that is already paying dividends in rising margins, Sinclair acknowledged, citing as an example a January promotion on a single item—locally grown strawberries—in the Southwest states.

“In the past, this would have meant trying to be the lowest price in town on a broad promotion across all berries, and we would have sold a lot of them but with very little profit,” Sinclair said. “Fast forward to 2020, we focused on a single item, strawberries, and the differentiation of the product being local. The strawberry sales in this region comped north of 20%, with a margin that was up tremendously from last year. This displays not only our ability to highlight fresh product, but how our scale is allowing us to partner with more local growers. As well, many of these new promotions are being advertised to a more targeted customer through digital, with deals that motivate our customers to spend more.”

Sinclair said the latest addition to his senior management team—the former H-E-B and Kroger private label guru Gil Phipps—would be “instrumental in shaping Sprout's long-term strategy to build brand awareness and loyalty with our target shopper. He brings a wealth of experience and development in building brands, and we look forward to his contributions to define and strengthen our private label.”

4 Years in 4 Weeks

A digital strategy around promotion and marketing will accompany a greater emphasis on e-commerce that could be the biggest outcome of the current crisis. Albeit from a relatively small base, Sinclair said e-commerce grew by 950% in April vs. last year and accounted for 13% of its total sales in the month. To this end, Sprouts is rushing to expand availability of pickup from about 55 stores to its entire footprint.

“I think e-commerce generally has accelerated across the United States for grocery. I think we’ve probably gone forward four years in four weeks," Sinclair said. 

He said he anticipated that growth to stabilize at some point. “We will have to make sure that we're capable of effectively servicing a bigger e-commerce business going forward,” he said. 

For now, Sinclair highlighted a unique partnership with Instacart for e-services, whereby Instacart is providing the technologies and delivery drivers but Sprouts is using its own workers to pick orders—a model Sinclair said was more efficient because its employees could shop inventory more effectively and provide additional help in stores.

“We definitely make money on our e-commerce business, both pickup and delivery,” Sinclair said. “It is a slightly lower-margin business because there are some additional costs that are paid through the system for that, but it is a profitable business.”

Analysts and the stock market reacted to Sprouts’ earnings call and future forecast positively. Its stock reached a 52-week high May 6, the morning after the call. Scott Mushkin of R5 Capital expressed some reservation over the potential loss of a historic leadership in pricing among fresh foods but acknowledged in a note to clients that “Sprouts’ future appears bright,” and reiterated a “strong buy” on the stock.

Chris Mandeville of Jefferies noted the promotional pivot’s contribution to profits but said traffic still awaits. “As COVID benefits abate and online … becomes more prominent, we believe better traffic might prove tough to come by,” he said.