The significant decline in the shares of Sprouts Farmers Market Inc (NASDAQ:SFM) has created a buying opportunity. The drop in SFM stock came after Amazon.com, Inc. (NASDAQ:AMZN) announced that it had agreed to buy Whole Foods Market, Inc. (NASDAQ:WFM) for $42 per share.
But worries about online competition to SFM stock look overblown, and there is a very good chance that it will be acquired. Moreover, Sprouts reported pretty good results in May, and the high food deflation that has been hurting all supermarkets’ results look to be easing.
Only 25% of American households buy any food online at all, and even by 2025, online sales will account for only 20% of annual grocery revenue, a Food Marketing Institute and Nielsen study reported recently found.
Another study found that only 12% of U.S. internet users bought groceries online at least once a month last year. Although Amazon will be able to sell Whole Foods’ products online, there is no evidence or reason to believe that many SFM customers will desert Sprouts to buy food on Amazon.
Moreover, of course there is nothing to prevent Sprouts Farmers Market from selling its own products online.
Meanwhile, there is a very good chance that Sprouts will be acquired. The company, which expects to report positive same-store sales this year and is well-positioned to attract many millennial shoppers, would be an attractive takeover target for many companies. Wal-Mart Stores Inc (NYSE:WMT), which has been trying to expand its online presence in an effort to compete more effectively with Amazon, is one potential suitor. Alibaba Group Holding Ltd (NYSE:BABA), which wants to meaningfully penetrate the U.S. market, is another. A large supermarket chain such as Kroger Co (NYSE:KR) or Albertsons which previously expressed interest in buying Sprouts, could also pull the trigger on a takeover.
And, as I pointed out in a prior column, one of the no-growth food dinosaurs such as General Mills, Inc. (NYSE:GIS) or Kellogg Company (NYSE:K) could very well buy Sprouts in order to give their products better shelf space in Sprouts’ stores and integrate their products with Sprout’s in-house offerings.
Research firm Oppenheimer, which upgraded SFM stock to “outperform” from “perform,” agrees that Sprouts could be acquired, saying that the grocery chain “could be the next target out there” after the Whole Foods deal. The firm added that the company’s fundamentals are solid, The Fly reported.
Macro trends are also looking more favorable for Sprouts. Food deflation has been easing significantly since November, and the grocery chain said that deflation on produce heading into the second quarter “went from double digit…to almost flat.” Furthermore, there is some evidence that young consumers’ salaries are rising significantly, which should meaningfully boost demand for Sprouts’ more expensive offerings.
Finally, as mentioned earlier, Sprouts’ results have held up pretty well despite multiple headwinds. Last month, the company reported first-quarter results that beat expectations as its same-store sales increased 1.1% versus the same period a year earlier. Moreover, SFM increased its fiscal 2017 earnings per share, revenue and same-store sales guidance.
The results suggest that the company is starting to see a lift from the macro trends I mentioned, while the strength of its brand is enabling it to withstand pressure from Amazon and new entrants to the grocery sector.
The decline in SFM stock after Amazon’s announcement was overdone, as polls indicate that online grocery buying isn’t likely to become very widespread anytime soon and SFM stock can offer its own products online. Furthermore, there is a a very good chance that Sprouts could be acquired, and its fundamentals look set to strengthen going forward. Investors should buy SFM stock on today’s weakness.
As of this writing, Larry Ramer did not own any shares of any of the companies mentioned.