The world’s best fund managers rate this tiny supermarket over bigger rivals – and so should you

sprouts farmers market
sprouts farmers market

Shoppers are increasingly told that natural foods are good for them and good for the planet, but are they good for the investors in the companies that sell them?

Amazon’s $13.7bn (£11bn) swoop on high-end American supermarket chain Whole Foods in 2017 added to the investor buzz around premium retailers of locally and ethically sourced foods.

But amid high inflation and the rising cost of living, investors are now questioning whether they can continue to attract growing numbers of customers willing to pay their higher prices. Despite Amazon’s promise to cut prices, Whole Foods has struggled to shake its “Whole Paycheck” nickname in America.

However, some of the world’s best fund managers believe they have found a company that can deliver the appeal of natural foods at a more palatable price for cost-conscious times.

Twenty-one of these investors, each among the top-performing 3pc of the 10,000 equity fund managers tracked by the financial publisher Citywire, have bought the shares of Sprouts Farmers Market, a small – by American standards – supermarket chain with a market value of $4.3bn.

Sprouts Farmers Market receives a top AAA rating from Citywire Elite Companies, which rates companies on the basis of their backing by the best-performing fund managers. Not only that, but the supermarket chain ranks among the top 10 most popular American companies for these investors, ahead of much bigger and better-known businesses.

Sprouts Farmers Market has been in business since 2002 and has steadily grown its revenues and profits in an established US natural food market. It has positioned itself as a place for health-conscious customers to buy natural and wholesome foods at affordable prices. A combination of keen pricing and discounts, along with a growing brand range, is its way of wooing shoppers.

The company believes that its close relationships with smaller producers give it a competitive edge by allowing it to buy high-quality products at lower prices than conventional supermarkets – and a lot lower than high-end specialist retailers.

The performance of the shares suggests that the business model is working. Since a pandemic low in 2020, after which Sprouts Farmers Market delivered a step-change in profits, the stock has been motoring, returning 214pc in sterling terms.

Its potential to become a more efficient retailer could unlock further gains. The plan is to increase its store numbers of just over 400 currently at a rate of 10pc per year for the next few years. More than half of its shops are located in California, Texas and Arizona and the company is now heading east to Florida, Georgia and the mid-Atlantic states.

As part of this expansion, it is shifting to smaller stores of around 21,000 sq ft, which tend to be more profitable and make it easier for customers to shop. This will be backed by investment in new distribution centres closer to its shops, which should ensure that products stay fresh and are cheaper to transport.

Internet sales are rising thanks to an effective partnership with delivery services DoorDash and Instacart, while higher-margin own-label sales are growing and now account for more than 20pc of the total.

The launch of a loyalty card is expected some time in 2024 and the customer data that come with it should provide a big boost to the company’s marketing efforts.

Sprouts Farmers Market is being conservative with its growth target for its existing stores of just 3pc a year. When combined with new and maturing stores, this should take revenue growth into the 7pc to 8pc range.

The company’s stores are more profitable than those of mainstream American supermarket rivals Walmart and Kroger, and deliver strong surplus cash flow. This cash is used to buy back shares rather than pay dividends. Over the past decade, Sprouts has shrunk the number of its shares in issue by nearly a third, boosting earnings per share in the process.

If all goes to plan, Sprouts Farmers Market could generate high single-digit earnings growth for shareholders. With the shares priced at 15 times forecast earnings for the next 12 months, some of the world’s best investors see them as good value, and this column agrees.

Questor says: buy
Ticker: Nasdaq: SFM
Share price at close: $42

Phil Oakley is a contributing journalist for Citywire Elite Companies

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