Sprouts Farmers Market Downgraded, But Fundamentals Remain Strong As Ever

After a 30-percent gain since the start of 2017, analysts at Morgan Stanley felt it prudent to downgrade Sprouts Farmers Market Inc SFM's rating, as the stock is now trading at an appropriate valuation relative to future growth.

Morgan Stanley's Vincent Sinisi downgraded Sprouts' stock rating from Overweight to Equal Weight with an unchanged $23 price target. While the analyst reiterated the organic food retailer's favorable outlook, the stock is now trading at a 25x multiple on his 2018 earnings per share estimate. This represents a 12-month high for the stock and a 25-percent premium to the food retail group Sinisi covers (check out Sinisi's track record here).

Moreover, Sprouts' stock is trading at a 2.4x PEG ratio based on his 2016–2019 EPS compounded annual growth rate forecast of 10.5 percent, which is also above the group's average of 1.6x among companies with an expected 10 percent EPS growth profile.

The Long-Term Story

Sprouts remains a strong retailer in the organic food segment as it sells low-price produce which serves as a compelling differentiator for customers, Sinisi explained. Meanwhile, Sprouts happens to be the only company within the analyst's coverage to report positive comps throughout the grocery deflationary cycle, but a return to 2012 to 2014's comp average of 10 percent is unlikely to be seen again, especially when factoring in the competitive environment.

Bottom line, the analyst sees a path toward 10-percent annual sales and EPS growth going forward, but this may be reflected in the stock's price at current levels.

At last check, shares of Sprouts were down 6.22 percent at $23.20.

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