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Shoppers enter a Sprouts Farmers Market in Los Angeles. Investors scrambled for a stake in the organic grocer when its stocks went public on Aug. 1. (JONATHAN ALCORN/REUTERS)
Shoppers enter a Sprouts Farmers Market in Los Angeles. Investors scrambled for a stake in the organic grocer when its stocks went public on Aug. 1. (JONATHAN ALCORN/REUTERS)

Groceries

Pick a basket of stocks from sizzling ‘shop organic’ sector Add to ...

It was the hottest U.S. stock debut in more than two years. Sprouts Farmers Market went public on the Nasdaq Stock Market on Aug. 1, and closed up a sizzling 123 per cent. Investors lucky enough to get in on the initial public offering enjoyed a tidy profit. For everyone else, the stock’s performance made them wonder whether there might be more money to be made in the organic and health-food sector.

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Sprouts Farmers Market is an organic grocery chain based in Phoenix. It operates more than 160 stores in eight states and has targeted 13 more states for expansion. It has increased sales at a compound annual rate of more than 17 per cent since 2008. That growth came about even as consumer spending has come under pressure since the financial crisis.

Sprouts is just one of the players riding one of the hottest trends in the food and retailing sectors. As a recent report by Pennsylvania-based Turner Investments says: “Shoppers are considering more than price when they make their food choices: They are taking into account environmental concerns, fair labour practices and food safety as well. For many consumers it’s a lifestyle choice that says as much about them as the clothes they wear and the car they drive.”

“Investors realize this is a trend that isn’t going away,” says Philip Terpolilli, an analyst at Longbow Research in Ohio. He sees two key “psychographic” factors playing into the growth of organic and natural foods.

“You have the baby boomer generation looking to live in a more healthy way as they get older. And the philosophy behind it also appeals to a lot of the younger millennial generation – especially the local and sustainable food movement.”

Other analysts are equally positive. Scott Van Winkle of Canaccord Genuity says he has recommended the natural and organic food space for 15 years, and is “all in” on the sector.

“The growth trends are significant and sustainable,” Mr. Van Winkle says. He notes that annual natural and organic food sales are estimated to total $30-billion in the United States and grew 12 per cent last year, according to the Nutrition Business Journal. He has a long-term target of 8- to 10-per-cent annual growth.

Many of the companies in the sector also benefit from wider profit margins, as consumers are willing to pay a premium for products that meet their specifications.

As far as investing in the sector, Mr. Van Winkle says his strategy has always been to find a strong macro trend and then pick a basket of stocks that benefit from that theme. His firm also looks for specific hot trends within the overall sector.

One subtrend Mr. Van Winkle identifies is gluten-free foods. The company he picks as a beneficiary of this trend is Boulder Brands. Boulder’s products include the Udi’s and Glutino brands. After falling in March following a disappointing earnings report, Boulder shares have surged by nearly 80 per cent.

Mr. Van Winkle’s other subtrend is non-genetically modified foods. He identifies a Toronto-based company as a beneficiary of this trend – SunOpta Inc. It is active in many different parts of the health-food business, including sourcing, processing, manufacturing and distributing. Its shares have climbed by more than 60 per cent in the past year.

Analyst Christine Healy at Bank of Nova Scotia is also bullish on SunOpta. She rates it as a “focus stock,” representing analysts’ top investing ideas. She is forecasting solid earnings growth for the company in the second half of this year, because of the completion of several projects. Those include the expansion and upgrades of several of its U.S. facilities, as well as expansion into new areas such as cocoa and plant fibre.

SunOpta is one of the few publicly traded Canadian companies in the organic and natural-foods sector. Certainly mass retailers such as Loblaw and Sobeys are expanding their offerings of healthier foods, in an attempt to prevent a loss of health-conscious customers. As well, quick-service franchise chain MTY Food Group Inc. is working on benefiting from the trend through its more health-focused banners such as Cultures, Jugo Juice and Yogen Fruz.

Analyst Mr. Terpolilli’s top pick in the natural and organic space is Hain Celestial. Hain makes some of the best-known brands in the sector, including Celestial Seasonings, Terra and Earth’s Best. Its total sales topped $1.3-billion (U.S.) last year.

One of the reasons Mr. Terpolilli likes Hain is it is insulated from the battle among retailers.

“Over the long-term, traditional retailers could increase their natural/organic selections, which could put pressure on organic/natural retailers,” he says. “But Hain benefits no matter which retailer wins. It has substantial brand equity with its products. It has also been doing well with acquisitions, consolidating brands, and also expanding internationally.”

The top retailer in the sector is Texas-based Whole Foods. It is the largest company by market capitalization in the sector, and the most broadly held stock. Like many U.S. equities it has enjoyed a hot summer, rising by nearly 30 per cent since mid-April.

Whole Foods has 355 stores, including eight in Canada, but it seems to have more room to grow. The company sees demand for as many as 1,000 stores in the United States alone. However some analysts see some possible obstacles ahead. Mr. Terpolilli says he’s concerned that any significant slowdown in consumer spending power could place some pressure on traffic and spending at Whole Foods. He also says increased promotional activity may become an unfavourable trend, as competing traditional grocers ramp up their natural and organic offerings.

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