S&P Raises Outlook on Sprouts Farmers Market (SFM) to Positive; Notes Improving Credit Metrics

Standard & Poor's Ratings Services revised its rating outlook on Phoenix-based Sprouts Farmers Market Inc. (Nasdaq: SFM) to positive from stable and affirmed the 'BB-' corporate credit rating.

At the same time, we raised our issue-level ratings on the Sprouts Farmers Markets Holdings LLC's $60 million revolving credit facility due 2018 and $700 million term loan B due 2020 to ‘BB’ from ‘BB-’ and revised our recovery ratings to '2' from '3'. This reflects revised recovery prospects because of less secured debt claims in our recovery analysis, given the debt repayment in the third quarter. The '2' recovery rating indicates our expectation for substantial (70% to 90%) recovery of principal in the event of payment default.

"The outlook revision reflects our view that Sprouts will continue to increase profits and improve credit metrics, as it successfully executes its growth strategy into new markets. It also incorporates our expectation that the company will continue to generate strong top-line growth and continue to deleverage over the next year, outpacing increased debt from new operating leases to support that growth," said credit analyst Kristina Koltunicki.

The positive outlook on Sprouts reflects the possibility that we could raise the corporate credit rating on the company one notch within the next 12 months if it continues to improve operating performance and credit metrics. At that time, we would also want further clarity on the company’s financial policy, particularly around future share repurchases, dividends, and allocation of
free cash flow.

Upside scenario

We could raise our ratings during the next 12 months if Sprouts continues to maintain credit protection measures reflective of a “significant” financial risk profile, including FFO/debt of more than 20% and FOCF/debt of more than 10%. An upgrade would also further necessitate a better understanding of the company’s financial policies including the likelihood of more aggressive debt-financed shareholder friendly activities that could deteriorate credit ratios from forecasted levels.

Downside scenario

We could revise the outlook to stable over the next 12 months if Sprouts’ operating performance is weaker than we expected, potentially because of a slower executed store expansion or an increase in competitive pressures. Under this scenario, gross margin would decline approximately 100 bps while comparable-store sales growth would be in the mid-single digits, leading to leverage increasing to the mid-3.0x area. We could also revise our outlook to stable if financial policies become more aggressive, evidenced by debt-financed share repurchases, leading to a leverage increase to similar
levels.

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