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Has Sprouts Farmers Market's Gross Margin Expansion Peaked?
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Key Takeaways
SFM's gross margin rose 129 bps in Q1 2025, aided by shrink leverage and tighter inventory controls.
The company expects margin growth to moderate starting Q2, with tougher comps.
SFM stock is up 36.4% YTD, outpacing the industry's 14.3% gain despite a higher valuation multiple.
Sprouts Farmers Market, Inc. (SFM - Free Report) registered a stellar performance in the first quarter of 2025, with the gross margin reaching 39.6%, a solid 129-basis-point increase from the year-ago level. The company attributed this expansion to improved inventory and category management, along with shrink leverage. But is this margin lift a structural trend or simply a short-term spike?
While these drivers are significant, they may be approaching their limit. Shrink benefits, in particular, came from “tight in-stocks” due to strong sales and supply constraints. Such upside is unlikely to continue if stock levels normalize. On its last earnings call, management acknowledged that Sprouts Farmers is likely to face tough year-over-year comparisons and a slowdown in comparable store sales growth as the year progresses. This may limit gains.
Sprouts Farmers also guided for gross margin normalization beginning in the second quarter. This implies a moderation in the rate of growth. We expect a gross margin expansion of 50 basis points in the second quarter, followed by modest increases of 10 basis points in both the third and fourth quarters. While the steepest part of the margin expansion curve may be behind, a gradual upward trend remains intact.
Despite normalization in the gross margin, SFM projects continued EBIT margin expansion. The company is making significant strides in its supply-chain strategy, including a shift to self-distribute fresh meat and seafood, starting in the third quarter. This, along with investments in the loyalty program and technology, is set to bolster margins over time.
SFM’s Margin Versus WMT and DG
Walmart Inc.’s (WMT - Free Report) gross margin expansion appears increasingly supported by structural advantages, yet headwinds loom. Walmart continues leveraging disciplined inventory management and improved e-commerce economics to drive gross margin gains, with the U.S. gross margin up 25 basis points in the first quarter of fiscal 2026. Walmart's e-commerce profitability and mix shift toward high-margin advertising and membership are helping offset pressure from tariffs. However, elevated tariffs, especially on Chinese imports, are a concern.
Dollar General Corporation’s (DG - Free Report) first-quarter fiscal 2025 gross margin expanded 78 basis points to 31%, driven by a 61-basis-point improvement in shrink and higher inventory markups. Dollar General’s ability to sustain margin improvement will be tested by tariff-related cost pressures. While mitigation strategies are in place, including vendor negotiations and sourcing diversification, Dollar General may face margin constraints.
SFM’s Price Performance, Valuation and Estimates
Sprouts Farmers stock has been a standout performer, with shares rallying 36.4% year to date, outpacing the industry’s growth of 14.3%.
Image Source: Zacks Investment Research
From a valuation standpoint, SFM's forward 12-month price-to-sales ratio stands at 1.84, higher than the industry’s ratio of 0.26. SFM carries a Value Score of D.
Image Source: Zacks Investment Research
The Zacks Consensus Estimate for Sprouts Farmers’ current financial-year sales and earnings per share implies year-over-year growth of 13.7% and 35.5%, respectively.
Image: Bigstock
Has Sprouts Farmers Market's Gross Margin Expansion Peaked?
Key Takeaways
Sprouts Farmers Market, Inc. (SFM - Free Report) registered a stellar performance in the first quarter of 2025, with the gross margin reaching 39.6%, a solid 129-basis-point increase from the year-ago level. The company attributed this expansion to improved inventory and category management, along with shrink leverage. But is this margin lift a structural trend or simply a short-term spike?
While these drivers are significant, they may be approaching their limit. Shrink benefits, in particular, came from “tight in-stocks” due to strong sales and supply constraints. Such upside is unlikely to continue if stock levels normalize. On its last earnings call, management acknowledged that Sprouts Farmers is likely to face tough year-over-year comparisons and a slowdown in comparable store sales growth as the year progresses. This may limit gains.
Sprouts Farmers also guided for gross margin normalization beginning in the second quarter. This implies a moderation in the rate of growth. We expect a gross margin expansion of 50 basis points in the second quarter, followed by modest increases of 10 basis points in both the third and fourth quarters. While the steepest part of the margin expansion curve may be behind, a gradual upward trend remains intact.
Despite normalization in the gross margin, SFM projects continued EBIT margin expansion. The company is making significant strides in its supply-chain strategy, including a shift to self-distribute fresh meat and seafood, starting in the third quarter. This, along with investments in the loyalty program and technology, is set to bolster margins over time.
SFM’s Margin Versus WMT and DG
Walmart Inc.’s (WMT - Free Report) gross margin expansion appears increasingly supported by structural advantages, yet headwinds loom. Walmart continues leveraging disciplined inventory management and improved e-commerce economics to drive gross margin gains, with the U.S. gross margin up 25 basis points in the first quarter of fiscal 2026. Walmart's e-commerce profitability and mix shift toward high-margin advertising and membership are helping offset pressure from tariffs. However, elevated tariffs, especially on Chinese imports, are a concern.
Dollar General Corporation’s (DG - Free Report) first-quarter fiscal 2025 gross margin expanded 78 basis points to 31%, driven by a 61-basis-point improvement in shrink and higher inventory markups. Dollar General’s ability to sustain margin improvement will be tested by tariff-related cost pressures. While mitigation strategies are in place, including vendor negotiations and sourcing diversification, Dollar General may face margin constraints.
SFM’s Price Performance, Valuation and Estimates
Sprouts Farmers stock has been a standout performer, with shares rallying 36.4% year to date, outpacing the industry’s growth of 14.3%.
Image Source: Zacks Investment Research
From a valuation standpoint, SFM's forward 12-month price-to-sales ratio stands at 1.84, higher than the industry’s ratio of 0.26. SFM carries a Value Score of D.
Image Source: Zacks Investment Research
The Zacks Consensus Estimate for Sprouts Farmers’ current financial-year sales and earnings per share implies year-over-year growth of 13.7% and 35.5%, respectively.
Image Source: Zacks Investment Research
Sprouts Farmers Market currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.