As a fundamental narrative, Sprouts Farmers Market (SFM) makes plenty of sense amid the rising challenges facing the consumer economy. Yes, it’s true that the May jobs report came in much hotter than expected, which implies resilience for the underlying post-pandemic recovery effort. At the same time, rumblings in the derivatives market suggests that not everything is well with SFM stock.
To be sure, the charts don’t provide much indication that Sprouts Farmers is struggling. Since the beginning of this year, SFM stock gained slightly over 14% of equity value. For context, that comes in just under the performance of the benchmark S&P 500 index during the same period. However, in the trailing year, SFM moved up almost 34%. In sharp contrast, the S&P 500 gained a bit over 15%.
Still, investors should be cautious about diving too heavily into SFM stock. While Sprouts benefits from budgetary considerations – as people can afford to axe discretionary purchases but not so much critical needs such as food and water – the post-COVID-19 paradigm is proving to be incredibly difficult to decipher.
SFM Stock Has Its Strengths But Bears Don’t Care
While the aforementioned May jobs report provided a positive read of the labor force, not all the details presented cause for encouragement. First, the length of the average work week declined to 34.3 hours from 34.4 hours in April, according to an AP report. Second, the pace of hourly wage growth also declined in May.
Notably, this decline suggests that many businesses feel less pressure to offer higher compensation as a mechanism to find and keep workers. By logical deduction, the labor market could be getting more competitive for job seekers. Therefore, even if the post-COVID recovery seems like a raging bull market, households need to be careful about their spending.
Logically, this framework bolsters the case for SFM stock and the broader grocery industry. While consumers may want the latest fashion or gadget, they don’t actually need them. However, nutritional sustenance is absolutely a non-negotiable. So, it stands to reason that Sprouts should benefit from consumer dollars focusing on the essentials.
However, options traders might not see it that way. Following the close of the June 14 session, SFM stock represented one of the top highlights for Barchart’s screener for unusual stock options volume. Specifically, total volume hit 6,433 contracts against an open interest reading of 30,803. Further, the delta between the Wednesday session volume and the trailing one-month average metric came out to 647.15%.
Drilling down, call volume mustered only 1,634 contracts while put volume landed at 4,799 contracts. This pairing yielded a put/call volume ratio of 2.94, on paper favoring the bears. Have the optimists been reading the wider circumstances incorrectly?
The Trade Down Within the Trade Down
To be completely upfront, investors shouldn’t craft an entire thesis around one day’s worth of unusual options volume. Nevertheless, it’s also possible that the heightened trading activity may provide an early warning indicator about the different gradations in the trade-down effect.
Basically, the trade-down effect involves consumers, when faced with financial challenges, choosing to elect cheaper alternatives to commonly purchased goods and services as opposed to going completely cold turkey. In many ways, grocers like Sprouts benefit from the trade-down effect as consumers eschew dining out for eating in.
Moreover, Sprouts specializes in quality, freshly grown food products; hence the name Sprouts Farmers Market. In other words, it makes sense for consumers to trade down their nights out for nights in with high-quality food.
However, as economic pressures rise, people are choosing to trade down while in the act of trading down. Specifically, Costco (COST) Chief Financial Officer Richard Galanti stated that he sees customers switching from beef products to less-expensive protein alternatives, like pork and chicken. That’s significant because Costco tends to cater to a higher-income consumer base, especially being a membership-only club.
With Sprouts, it may now face challenges from large national grocers like Kroger (KR), which benefit from more product variety and superior economies of scale. These and other attributes may help the majors win the price war.
Ultimately, the lesson here is that even if a business features core relevancies, that’s no guarantee of success in this tricky economic environment.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
