What a brutal six months it’s been for Grocery Outlet. The stock has dropped 47.6% and now trades at $8.12, rattling many shareholders. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is now the time to buy Grocery Outlet, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
Why Do We Think Grocery Outlet Will Underperform?
Despite the more favorable entry price, we don't have much confidence in Grocery Outlet. Here are three reasons why GO doesn't excite us and a stock we'd rather own.
1. Same-Store Sales Falling Behind Peers
Same-store sales show the change in sales for a retailer's e-commerce platform and brick-and-mortar shops that have existed for at least a year. This is a key performance indicator because it measures organic growth.
Grocery Outlet’s demand within its existing locations has been relatively stable over the last two years but was below most retailers. On average, the company’s same-store sales have grown by 1.6% per year.
2. Shrinking Operating Margin
Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.
Analyzing the trend in its profitability, Grocery Outlet’s operating margin decreased by 6.5 percentage points over the last year. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Grocery Outlet’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 4.7%.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Grocery Outlet’s $1.81 billion of debt exceeds the $69.6 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $254.3 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Grocery Outlet could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Grocery Outlet can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping consumers, but in the case of Grocery Outlet, we’re out. Following the recent decline, the stock trades at 15.8× forward P/E (or $8.12 per share). At this valuation, there’s a lot of good news priced in - we think other companies feature superior fundamentals at the moment. We’d recommend looking at one of our top digital advertising picks.
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