RF Capital Management LLC, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A net return of 55.17% was recorded by the fund for the first half of 2021. The fund has gotten off to a strong start this year – especially in the first quarter where it generated a 42.82% return net of all fees. You can take a look at the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of RF Capital Management, the fund mentioned Sprouts Farmers Market, Inc. (NASDAQ: SFM) and discussed its stance on the firm. Sprouts Farmers Market, Inc. is a Phoenix, Arizona-based supermarket company with a $2.5 billion market capitalization. SFM delivered a 12.36% return since the beginning of the year, while its 12-month returns are up by 9.58%. The stock closed at $22.98 per share on September 13, 2021.
Here is what RF Capital Management has to say about Sprouts Farmers Market, Inc. in its Q2 2021 investor letter:
“Sprouts struggled in the second quarter due to the improving COVID-19 situation. Sales, comparable store sales, and earnings were all down QoQ – not surprising given how customers are enjoying traveling and dining out again. Furthermore, several new store openings have been delayed. More specifically, twenty new store openings have been inked this year but may be delayed due to supply chain issues, and seven store openings have been pushed back until 2022. Additionally, management projects that net sales for the year will be down low-single digits and comparable store sales will decline 5% to 7%.
Despite the weak quarter, management remains committed to their goal of 10% unit growth. Their unit growth goal is certainly doable given that there is room for another 300 to 400 new stores in expansion markets (California, Texas, Georgia, Florida, New York, New Jersey, Delaware, and Maryland). Furthermore, new distribution centers can be built in Florida, New York, and Colorado. The addition of new DCs is important operationally, and management targets having DCs within 250 miles of every store.
On top of unit growth, management is also targeting low double-digit earnings growth annually. Through new store openings, it wouldn’t be difficult for Sprouts to realize that goal. New store economics remain attractive. Typically, new stores generate 20%-25% sales growth, $16M- $18M in sales, blended 8% EBITDA margins, and cash-on-cash returns of ~40% in year 4. Furthermore, new stores are now smaller (21K-25K sq. ft. compared to 30K historically), which improves CapEx and profitability.
Although SFM’s growth opportunity is attractive, analysts are more focused on other issues such as foot traffic, competitors, and promotions at the moment. While these concerns are wellfounded, analysts and investors should view SFM’s challenges from a different perspective. With foot traffic, SFM targets a specific customer base. Customers who shop at SFM have different priorities and habits than those that shop at Kroger, Albertsons, Walmart, et al. Additionally, the product mix at Sprouts is different from competitors such as Kroger. (SFM’s product mix is closer to that of Whole Foods and Trader Joe’s.) Thus, it’s unrealistic to expect Sprouts to attract shoppers who are not part of the target customer base. While Sprouts could attract more customers through promotions and deals, coupons and lower prices are not a long-term solution. What SFM needs to focus on is extracting more dollars from existing baskets. Existing customers are more likely to continue shopping at Sprouts over the long term. Shoppers that come into the stores just for the coupons and deals are fleeting.
Sprouts remains one of our largest holdings at 15% of the portfolio. Our initial average cost basis was $16.32/share. We continue to maintain our position given new store unit growth, projected double-digit earnings growth, the increasing trend of being more health-conscious and adopting organic/keto/gluten-free foods into one’s diet, and the uncertainty of COVID-19 variants and their impact on consumer behavior.”
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Based on our calculations, Sprouts Farmers Market, Inc. (NASDAQ: SFM) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. SFM was in 25 hedge fund portfolios at the end of the first half of 2021, compared to 21 funds in the previous quarter. Sprouts Farmers Market, Inc. (NASDAQ: SFM) delivered a -20.27% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
