Call to Action: Sprouts Wrestles With Comp Dilemma

Sprouts Farmers Market officials are confident they have the strategy and the financials right. What they’re continuing to miss are customer traffic and sales.

The conundrum was illustrated in a 7% sales decline for the Phoenix-based natural foods chain, with comps tumbling by 10% in its fiscal second quarter ending July 4. The comp decline was well in excess of market expectations of a 6% slide, and prompted revised guidance now calling for a low single-digit comp decline for the fiscal year vs. a previous expectation of flat comps. Hefty gross profit margins of 36.1% of sales on the other hand drove net income of $61 million and earnings per share of 52 cents, which were better than Wall Street had anticipated.

On a two-year stack, comps were down by 0.6%, reflecting both the complications of the COVID pandemic but also the chain’s move to radically alter its go-to-market strategy during the period, abandoning the highly promotional prices it once touted—and the shoppers who came for them—to focus instead on appeal on a smaller set of more discerning shoppers responsive to a differentiated assortment focused on wellness and unique foods. CEO Jack Sinclair undertook this new approach shortly after joining the company two years ago; the 2019 second quarter was the last under its previous administration.

Sinclair spent a lengthy conference call taking questions from analysts about the chain’s plan to stimulate traffic and better balance the mix of profits and sales without going back to aggressive pricing. He acknowledged that the pandemic, and a subsequent move among consumers to consolidate their shopping trips in response, magnified traffic woes and was, to an extent, out of his hands to solve. But he also pledged a need to draw shoppers with more effective “call-to-action” promotions that bring “clarity and immediacy” to the changes the chain had undertaken while shoppers were away. And he insisted it would not take many new shoppers to right the ship.

“It’s not like we’re losing customers,” Sinclair said, “but we’re not gaining them as fast as we’d like to.”

Much of Sprouts’ growth strategy—including its plan to grow its store base by 10% annually—depends on the support of growing comps, even modestly, Sinclair acknowledged, but at the same time he’s strongly opposed to resuming 10 for $1 corn. “Could we drive traffic by going back to aggressive pricing? Probably. Would it be the wrong people coming into the stores? Probably. Would it help us? Probably not,” he said.

'Comps Stink'

Analyst Scott Mushkin of R5 Capital, after visiting numerous Sprouts stores in recent weeks, including newly revamped models, said the challenge won’t be easy.

“Store execution is very strong, the natural/organic/specialty merchandise resonates well with today’s consumer, pricing is good relative to competition and the smaller box size and open floor plan provide a convenient and easy shopping experience,” Mushkin wrote in a note to clients. “Yet, comps stink.”

Sinclair said the “call to action” promotions would involve stimulating demand—not with hot prices but with events and merchandising around differentiated assortments and categories to draw target “health enthusiasts and experience seekers” to the franchise. The effort is still in early stages, he said, but results so far have disappointed.

“We’re very pleased it’s giving us good awareness scores, which has always been a problem for the business, and it’s also giving us good intent to purchase. But what it’s not doing is translating itself into more people coming in, which we would have expected to happen by now,” he said.

“We don’t need that many more customers for the equation of this to work, and the good thing from my point of view as we look at different tactics and calls to action to drive that traffic, because of the financial strength of our model now, we’ve got a lot of arrows in our quiver, and we can deploy them,” he added. “We can do a number of things, test a number of thing in different places regionally, and in different category approaches, that’s what we’re encouraged about going forward—we’ve got room to play and a lot of options we’re working on. I’m feeling pretty confident that the base that we’ve built, the merchandising changes we’ve made, the supply chain changes that we’ve made, the real estate changes that we’ve made, puts us in a strong position with the target customers, and as we’ve said often, there’s enough of them. We don’t need many of them for this thing to look very dramatic.”

Mushkin said his impressions upon visiting revamped stores was that the experience could be “a bit staid” and that fresh food quality could be more consistent, acknowledging that newly built distribution centers closer to stores—another element of Sinclair’s strategy—could improve the latter concern. The “call to action” promotion “is a sensible approach in our minds,” he added. “The question is whether it will provide enough buzz to change the trajectory, which is hard to judge as management is just starting to do this.”

Sprouts' new store format is a strong in execution but its experience is "it bit staid," one analyst said. Rendering courtesy of Sprouts.

Pandemic Fatigue

Pandemic shopping trends over the past 17 months that have strongly benefitted Sprouts’ competitors in the conventional supermarket space—their wider assortments and convenient locations were advantages as shoppers reduced the number of venues they visit to buy food—have complicated Sprouts’ turnaround, Sinclair acknowledged. But he resisted the notion that those outlets would necessarily withhold the kind of shoppers Spouts is seeking with loyalty or pricing alone.

“The challenge for is not so much can we get them back from Kroger; it’s can we get the message out to those customers who have an affinity to who we are but haven’t gotten into the store,” he said. “If it's simply COVID that’s done that, I think it will happen automatically. If you’ve gone to Kroger—or anybody in the context of consolidating your shop—and you’ve gone in and said, ‘They have natural and organic,’ I promise you the scale of the differentiation of what we sell—the pricing on produce, the differentiation from vitamins and HABA [health and beauty aids], the bulk assortment that we’ve got; the attribute-based products we’ve got—is so different.”

Like its niche peers, Sprouts is anxious for pandemic effects to recede. “We’re doing our best not to talk about the pandemic going forward; we’re trying to talk about now COVID’s over and we're looking forward to getting back in Q3 and Q4 in terms of really driving the traffic within the strategy we’ve outlined.”

Sprouts still intends to grow stores by 10% annually but said delays in acquisition of refrigeration equipment related to global supply-chain gluts could push as many as seven stores planned to open this year back to 2022. Officials said that would not impact 2022’s planned store growth.

Sinclair defended the continued rollout despite its current sales woes.

“We don’t need crazy comps to make this thing work,” he said. “If you can deliver superior returns on a relatively modest store base, then the opportunity for us to grow comes with building a lot of stores in places we don’t exist.”