“We have had tremendous opportunity to expand a well-worth brand with a unique healthy product assortment across the United States. We have a great foundation, but we have significant work to do,” Jack Sinclair, who took the helm of Sprouts in June, told analysts during the company’s second quarterly call last Thursday.
While he acknowledged that he does not have all the answers as to how Sprouts will improve, develop and grow, he said he plans to “evolve the business model to be even more efficient and effective;” to foster a culture of transparency, accountability and open dialogue with stores and customers to help improve the business; and finally to “build a world-class executive team with depth and diversity and a capability to capitalize on the significant growth opportunity in front of Sprouts.”
That opportunity includes tapping into consumers’ growing interested in fresh, healthy and affordable food, he said.
“The competition is fierce and there are many retail outlets where customers can find food – even healthy foods,” he explained. But, he added, “the future will be defined by those that follow the customers, those that stay in front of or create the product trends, those that bring a differentiated and unique experience both in-store and digitally. And those will growth profitably. They will be the winners. And I’m confident that Sprouts can be at the forefront.”
Chip Molloy, Sprouts’ interim chief financial officer and a member of the board of directors, echoed Sinclair’s optimism for the future given Sinclair’s experience 35-plus years of grocery experience. But, he also said, the road ahead will not be easy and the board is not happy with recent results.
“Speaking for our board of directors, we still believe there is a tremendous opportunity going forward for Sprouts. The passion our customers and team members have for our brand combined with a white space opportunity to extend our reach both from a marketing and new store perspective is not just encouraging, but exciting,” he told analysts.
However, he added, “there is work to be done and we are not satisfied with recent results. We believe the hiring of Jack is a major step towards reversing recent trends and creating a path that captures the opportunity in front of us.”
A series of setbacks
Among the setbacks that disappointed the board are a drop in the company’s net income to $35 million in the quarter compared to $42 million from the same period in 2018 despite a 7% increase in net sales during the period to $1.4 billion.
Similarly, comparable store sales were discouragingly flat at 0.1% and two-year comparable stores sales growth was only 2.1%.
In response, the company adjusted its guidance down with a new expectation of net sales growth for the year at 7% to 8% with essentially flat comps, Molloy said. He added gross margins should be down about 20 to 30 basis points and the earnings per share should be between $1.05 and $1.09.
Molloy suggested that the comparable store sales of maturing stores may not be as high as the board believes they should be because the company has focused heavily on grand openings, but then failed to provide sufficient support in terms of a good marketing plan, good branding plan and helping customers throughout the marketplace understand what Sprouts stands for.
Sinclair added that the company’s promotional mix of everyday low prices and high-low “has probably got out of sync and there’s an opportunity for us, I think, not only to grow the comps but stabilize the margins at the same time.”
He also suggested that the company could take better advantage of its format, pricing and product mix compared to other grocers.
Product innovation, ecommerce offer hope for growth
While the company and Sinclair as its new CEO certainly have many challenges to address, there also are several areas of opportunity on which Sprouts already is acting.
For example, the company’s product innovation continues to drive double-digit sales growth in private label, which reached 14% of the company’s total revenue in the second quarter, according to Molloy.
“More than 45% of our basket contains private label items, the testament for the consumer adoption of our brand,” he said, adding that increased product cost is now fully reflected in retail pricing along with slightly higher distribution and transportation costs. This would suggest that gross margins, which decreased 35 basis points to 32.8% in quarter compared to the same time last year, should improve.
Sprouts also see significant potential in its ecommerce business, Molloy said.
“Our online sales, which are still relatively small in total, increased 170% expanding our reach to new customers while also providing a convenient alternative to current customers,” he said. “The online basket has a higher penetration of private label items and less promotional items producing a higher gross margin. In addition, our click and collect test has expanded in the Phoenix market as we further engage with customers regardless of how they shop.”
Leadership also see significant opportunity in the six new stores that Sprouts opened during the second quarter, which cost $84 million in capital expenditures. However, Molloy and Sinclair agree that the firm might tweak its approach to expansion.
“We are sitting here as a company with what we believe is a differentiated model with differentiated product, differentiated experience in the stores, with a lot of white space in front of us,” Molloy said. “So, yes, we are going to reevaluate how we go to market and how we extend our reach and we’re going to look at how big the box is, how much the box costs and how fast we can grow this. I don’t foresee us slowing down growth. If anything, its going to go the other direction.”
Sinclair added that “there probably is an opportunity for us to approach this store growth slightly differently in terms of how we’ve operated. And in looking at the format, I think there is opportunity to do them slightly smaller and probably and opportunity to do them in a slightly more concentrated geographic approach going forward.”