Forget Whole Foods: This Stock Yields 6.4% And Could Jump 250%

StreetAuthority Network

Grocery stores don't usually provoke thoughts of big gains from investors. And that's for a good reason. The domestic grocery market is relatively mature, with analysts projecting annual sales growth of 1% in the next few years.

But there is one segment of the domestic grocery market that continues to experience explosive growth. With consumers increasingly prioritizing health and wellness, annual organic food sales are on pace to reach $42 billion in 2014, an increase of 31% from $29 billion in 2010.

That bullish trend has been fueling market-beating gains for leading organic grocer Whole Foods Market (WFM).

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Although Whole Foods is a great company that will continue to profit from the bullish trend in organic food, its market cap of $20 billion and status as a large cap means it is probably past peak growth.

That's why investors looking for an opportunity with greater potential to cash in on the bullish trend in organic food should check out a small-cap grocer that is one of Wall Street's best-kept secrets.

On the surface, Roundy's (RNDY) looks like a typical regional grocer. The company operates 160 stores under five names in Illinois, Wisconsin and Minnesota. But a closer look reveals that Mariano's Fresh Markets, one of Roundy's pet projects, is tapping into the bullish trend in organics and health foods. Investors have taken notice:

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Much like Whole Foods, Mariano's Fresh Markets caters to higher-end consumers who prioritize quality over price. But what distinguishes the company from Whole Foods is its emphasis on value, offering a lower-cost alternative in a market where unemployment remains high and wages stagnant. Mariano's also aims to get its high-end consumers to notice lower prices on regular items like toilet paper and laundry detergent to save them a trip to Costco (Nadsaq:COST) or Wal-Mart (WMT).

The concept is ambitious, but the early results have been phenomenal. Mariano's grocery stores are producing an average $50 million in annual sales, nearly double the $20 million to $25 million of a typical grocery store. But in spite of those impressive sales volumes, Roundy's thinks Mariano's stores can continue to grow, projecting double-digit same-store sales growth on an ongoing basis, handily outpacing its industry and company peers.

That bullish outlook has been fueling new store openings, with Mariano's opening its ninth store in Chicago this spring after opening its first less than three years ago. Mariano's expects the Chicago market can support 30 stores, with a target of five new store openings a year. The success of Mariano's in Chicago is considered a blueprint for national and international growth, creating huge opportunities for early investors in a concept that is seeing impressive gains in a highly competitive market.

But the Mariano's growth story isn't the only reason to be bullish on Roundy's. The company also boasts a strong core business as a leading regional grocer, holding the No. 1 or 2 market share in five of its six primary markets. And Roundy's is focused on maintaining its leading position, implementing financial and operational strategies in 14 Milwaukee stores this year to drive sales and margin growth. With the new program producing encouraging results, management expects to begin rolling out these initiatives in other locations in the second half of the year.

Roundy's also boasts a sizable dividend yield of 6.4%, which compares with its grocer peer average of 2% to 3%. Free cash flow is expected to top $50 million this year, so the company's annual dividend payment of $22 million looks sustainable.

Risks to Consider: Roundy's has a market cap of $243 million, making it vulnerable to the volatility that is common among small caps. Grocery stores are also being pressured on gross margins as the costs of food ingredients and commodities rise. 

Action to Take --> Despite the bullish outlook for Mariano's, leading position in multiple markets and a huge dividend yield, Roundy's still looks undervalued, trading with a forward P/E (price-to-earnings) ratio of just 8, a sharp discount to its peer average of 20. If Roundy's traded with the same valuation as its peers, shares could jump to $19, a 250% gain from current levels.

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