What a brutal six months it’s been for Grocery Outlet. The stock has dropped 29.1% and now trades at $7.89, rattling many shareholders. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Grocery Outlet, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Grocery Outlet Will Underperform?
Even with the cheaper entry price, we're swiping left on Grocery Outlet for now. Here are three reasons why GO doesn't excite us and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
Grocery Outlet’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.
2. Shrinking Operating Margin
Operating margin is an important measure of profitability for retailers as it accounts for all expenses necessary to run a store, including wages, inventory, rent, advertising, and other administrative costs.
Analyzing the trend in its profitability, Grocery Outlet’s operating margin decreased by 9.2 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 8%.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Grocery Outlet’s $1.84 billion of debt exceeds the $59 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $245.5 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 cheer for all companies serving everyday consumers, but in the case of Grocery Outlet, we’ll be cheering from the sidelines. Following the recent decline, the stock trades at 15.3× forward P/E (or $7.89 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward a dominant Aerospace business that has perfected its M&A strategy.
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