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Sprouts’ Gross Margin to Remain Flat in Fiscal 2017

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Margins come under pressure in fiscal 2016

Sprouts Farmers Market (SFM) delivered industry-leading comps and profitability in fiscal 2014 and 2015. However, as discussed in the previous part of this series, the company faced deflationary headwinds and rising competition in 2016, which put pressure on its comps as well as margins. We discussed the company’s top-line performance in the last two sections, and in this article, we’ll look at the company’s profitability.

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Sprouts Farmers’ earnings per share rose 50% and 19% in fiscal 2014 and 2015, respectively. However, in 2016, EPS fell 3.6% to 83 cents as net income fell 7.6% to $124 million. Lower net profit was a result of a ten-basis-point decline in gross margin accompanied by a 19% increase in SG&A (selling, general, and administrative) expenses and a 17% rise in direct selling costs during the year.

Fiscal 2017 margin expectations

For fiscal 2017, the management is expecting flat gross margins. For the first half of the year, gross margin is predicted to fall as the company continues to make price investments to drive traffic and maintain its market share.

Direct store expenses are predicted to fall as a percentage of sales, while SG&A expenses are expected to remain relatively flat or fall slightly.

Analysts expect earnings per share to return to growth, increasing in the 4%–8% range. While earnings are likely to remain slightly positive in the first half of the year, stronger EPS growth is predicted in the second half.

Wall Street is in line with the management with predictions of 7.2% growth in earnings to 89 cents per share for the full fiscal year. For 1Q17, earnings are likely to remain flat at 30 cents per share.

While Sprouts’ earnings growth is likely to slow down, the company’s performance expectations are better than expectations for peers. Whole Foods Market’s (WFM) EPS are likely to fall 0.6% over the next year. Kroger (KR) is expected to witness EPS growth of 3.6%.

Investors who want to invest in SFM through ETFs can consider the SPDR S&P Retail ETF (XRT). SFM makes up approximately 1.4% of XRT.

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