Sprouts: Attractive Grocery Business With Friendly Capital Allocation

Jim and Abigail Zimmerman of Lowell Capital Management presented their investment thesis on Sprouts Farmers Market (US: SFM) at Wide-Moat Investing Summit 2023.

Thesis summary:

Sprouts Farmers Market is a natural, organic grocer trading at a low multiple despite a strong growth and margin profile, a “Ft. Knox” balance sheet, and a plan to profitably grow its store base 10% per year. SFM is a fresh, natural, and organic food market founded in 2002 in Phoenix, Arizona. SFM has a healthy differentiated store concept which operates between a local produce market and healthy grocers like Trader Joe’s and Whole Foods. SFM has a focus on produce, which comprises 20% of SFM total sales.

SFM recently traded at about 7x LTM adjusted EBITDA and about 13x adjusted EPS for 2023. Jim and Abigail believe SFM can grow sustainably at attractive rates for several years because SFM offers differentiated products in its stores — only 11% of merchandise overlaps with Walmart. CEO Jack Sinclair, joined in 2019 and shifted SFM’s strategy towards offering items that customers could not get in other grocery stores and away from competing on price and reduced reliance on flyers to offer discounts to drive traffic.

SFM has a strong cash-generative business model. SFM can use its strong cash flow to internally fund both growth capital expenditures and significant share repurchases. Also, the “Ft. Knox” balance sheet greatly reduces the risk of an investment.

Jim and Abigail believe SFM could grow its store base by 10% annually with low single digit comp sales over the next several years and repurchase about 5% of diluted shares annually. SFM should be able to drive adjusted EPS growth at a 15% to 20% annual rate over the next several years and achieve adjusted EPS of close to $3.50 per share by 2025 or 2026. Based on a stronger, more reliable earnings trajectory, SFM could trade for 20x adjusted EPS or about $70 per share versus its recent $35 per share price. Further, SFM could represent an attractive purchase to a strategic or financial purchaser.

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About the instructor:

Jim Zimmerman is founder and portfolio manager of Lowell Capital Value Partners, LP, successor fund to Lowell Capital Fund, L.P. Jim managed Lowell Capital Fund L.P. from 2003 to 2015 employing a proprietary strategy laser-focused on smaller and/or misunderstood companies with large, sustainable free cash flow yields and “Ft. Knox” balance sheets. He generated a compound annual return significantly exceeding the HFRI Equity Hedge Index and the S&P 500 Total Return Index over this period, despite holding a significant net cash position (~30%) for most of this period. Jim has over 25 years of investment banking and investment management experience in a variety of industries and has been involved with several billion dollars of investments. Jim graduated with a BA with high honors in economics from Princeton University in 1980 and an MBA from Stanford Business School in 1984. He worked at Drexel Burnham Lambert, Inc., 1984 to 1990, serving in the Corporate Finance Department and multiple other investment banks from 1990 to 2003.

Abigail Zimmerman works alongside her father at Lowell Capital. Abigail earned her B.A. in Business Administration at Loyola Marymount University in Los Angeles and has worked with Jim for the last several years. She assists in the generation of new ideas, administrative duties, research of small and medium cap companies, and detailed due diligence on potential investments.

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