Who Will Win the Grocery Store Wars, the Big Guys or a Newcomer?

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Just when you think the grocery-store wars couldn't get any more competitive, Sprouts Farmers Market pops up with an IPO. Sprouts considers itself a specialty retailer of natural and organic foods and products. It offers meats, produce, dairy, juices, baked goods, frozen foods, bulk foods, prepared foods, vitamins, supplements, and herbal concoctions.

What it doesn't offer is just as important, since the 25,000 to 35,000 square foot stores are about half the size of a standard grocery store, such as Kroger . You won't find aisles upon aisles of frozen foods, snacks and crackers, cleaning products, laundry detergents, and non-food items.

Safeway considers itself one of the largest grocery-store retailers in the United States. It boasts 1,406 stores in the Southwestern, Western, Mid-Atlantic, and RockyMountain regions. Kroger has 2,414 stores in 31 states. Both Safeway and Kroger dwarf Sprouts, which has only 160 stores in eight states, but bigger isn't necessarily better in this case.


Sprouts went public on Aug. 2. So does being a public company agree with Sprouts? It would seem so based on third-quarter results.

Growing strong
Sprouts' sales increased to $633.6 million, a 24% improvement from the third quarter of last year. That growth was  fueled by additional traffic, an increase in the amount of purchases per customer, and additional stores.

The acquisition of the 38 stores of Sunflower Farmers Market in May of 2012 is included in both the third quarter of 2012 and the third quarter of 2013. However, the additional stores will positively impact the full-year results. Additionally, 55 new leases have been signed for 2014. As a percentage, that's a growth rate of 34% in new stores.

This aggressive growth strategy is more than matched in the number of stores resulting from Kroger's merger with Harris Teeter, which gives Kroger 212 new stores. However, as a percentage those 212 stores are only an 8.8% increase. Kroger's sales were $22.5 billion for the third quarter, or $9.3 million per store. Sprouts' sales were nearly $4 million per store, while Safeway sales were $8.6 billion from continuing operations, or $6 million per store.

Consolidation pains
The story isn't so sunny for Safeway, which is consolidating its number of stores. It also announced that it will exit the Chicago market by selling 72 Dominick stores. Its Canadian operations were sold to Sobey's in October. The $5.8 billion in cash from these sales is projected by pay down debt of $2 billion with the remainder going to buy back stock.

Gross margin and operating profits going gangbusters
The gross profit margin for Sprouts shot up to $190.1 million in the third quarter, an improvement of 30% over the same quarter 2012. The $190.1 was 30% of sales. The margin would have been higher but some of that gain was eaten up by higher costs for scarce produce items.

While a store like Kroger is less affected by changes in produce because it sells a wider variety of other items, about one-third of the square footage of a Sprouts is devoted to produce. Consequently, produce price changes impact the company's gross margin more severely. Safeway's gross margin of $2.2 billion declined 36 basis points to 25.8% for the third quarter based on increased shrink expenses offset by reduced advertising. Kroger's gross margin of $4.6 billion improved 4.3%, but was only 20.5% of sales as compared to Sprout's 30% of sales.

Safeway's operating profit of $81.6 million declined 0.9% while Sprout's operating profit of $36.6 million nearly tripled from the same quarter in 2012. Kroger's operating profit was $534 million, or about $220,000 per store, compared to Sprout's slightly more than $229,000 per store. Sprouts handily beat out Safeway's operating profit of $58,000 per store as well.

Can the David of grocery stores challenge the giants?
Safeway and Kroger may be the Goliaths of grocery stores, but their performance is being challenged by Sprouts. The question is if the business model of offering primarily produce, bulk goods, prepared foods, and organic products will continue to attract shoppers when compared to the convenience of one-stop shopping.

I vote yes, and so does Doug Sanders, president and CEO. In the press release announcing the third-quarter results he said, "We are pleased to report another strong quarter, evidence of our customers' desire for fresh, natural and organic food at affordable prices."

 

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The article Who Will Win the Grocery Store Wars, the Big Guys or a Newcomer? originally appeared on Fool.com.

Dee Power has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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