Wells Fargo: Sprouts' Bull Thesis Shrivels Amid Low Inflation, Intense Competition

Sprouts Farmers Market Inc (NASDAQ: SFM) has ridden consumer sentiment, takeover speculation and strong first-quarter results to trade at its highest rate since Amazon.com, Inc. (NASDAQ: AMZN) bought out Whole Foods. But valuation may be peaking, according to Wells Fargo.

The Rating

Analysts Edward Kelly, Stephanie Chang and Anthony Bonadio downgraded Sprouts to Market Perform and maintained a $26 price target.

The Thesis

Overall, the analysts consider the grocer a “solid growth story.”

“Its emphasis on fresh helps combat the digital threat, its value model should continue to yield share gains from conventional grocers, and plenty of white space remains given the opportunity in regions like the attractive Northeast market,” Kelly, Chang and Bonadio wrote in a Monday note.

Nonetheless, intense competition in the grocery industry, particularly during a period of consolidation and rapid tech integration, introduces uncertainty around future performance.

“Price competition seems to have stabilized for now, but SFM has high exposure to key battleground categories in fresh and many of its large conventional competitors are not sharp enough on price,” Wells Fargo wrote. “The shift to digital should drive the cost of sustaining/growing share higher, and there remains uncertainty over the ideal strategy.”

Meanwhile, Amazon’s evolution presents headline risk, and management faces tough sales and margin comparables in the back half of the year. Wells Fargo detected a headwind in stagnant inflation — a factor expected to plague the firm in the near-term.

The analysts conceded the possibility of consolidation but, given high uncertainty, omitted the opportunity from valuation.

Price Action

At time of publication, shares were trading around $27.58.

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