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Why Grocery Outlet Could Have Investment Appeal

Grocery Outlet Holding Corp. (NASDAQ:GO) could deliver further stock price growth following its 10% rise since its initial public offering in June.

The grocery retailer is opening new stores, investing in new technology and seeking to differentiate itself from competitors

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New store openings

The company opened eight new stores during the third quarter, bringing the total number of new stores for the year to 24. It now has 337 stores in total. It plans to open nine additional stores in the fourth quarter.

The performance of its new stores has been in line with its own expectations, and has met its goal of increasing its total store numbers at a 10% annualized rate. Grocery Outlet is focusing on opening new stores in new markets, such as Southern California and the Mid-Atlantic. This could increase the size of its potential customer base and diversify its growth opportunities.

Investing in new technology

Grocery Outlet has invested in a custom-made in-house system that manages the movement of products between its warehouses and its stores. The system provides up-to-date information on the availability of specific products, as well as a more extensive amount of data on the sales of certain products.

This allows the company to have a more efficient ordering process that does not result in obsolete inventory. It also helps the business to identify fast-selling items in specific stores so that it can re-order them. This could lead to improving sales trends across Grocery Outlet's stores, as well as greater efficiency that helps to reduce costs. The retailer plans to refine the system to gain further benefits from it in the future.

Differentiation

Grocery Outlet's business model uses independent operators, which are essentially store managers, to run its stores. They have significant autonomy to make their own store appealing to the local population, such as through selecting around 75% of the products that they sell. This helps to make the company's stores different from their local rivals' stores, and may enable them to react faster to changes in consumer tastes. This could provide Grocery Outlet with a competitive advantage versus its sector peers.

Its independent operator business model is enhanced by its national marketing efforts. It plans to use increasingly personalized recommendations for its email subscribers that highlight high-margin products in its local stores. This could boost its sales per customer and catalyze its financial performance.

Potential threats

The outlook for U.S. retailers could deteriorate in the short run. The ongoing trade war between the U.S. and China is causing consumers to become increasingly cautious in regard to their spending. This is illustrated by the third consecutive monthly decline in the Conference Board's consumer sentiment index in October. Further declines in consumer confidence could cause Grocery Outlet's customers to become increasingly price-conscious, which may put pressure on the company's sales prospects and its margins.

In response, the company is partnering with an external business to improve the efficiency of its supply chain. It is also aiming to become increasingly opportunistic in its purchasing to take advantage of possible discounts that may improve its margins. This strategy contributed to an increase of 0.4 percentage points in Grocery Outlet's gross margin to 30.8% in the third quarter.

In addition, the company hopes manage its inventory levels more effectively to reduce waste and cut costs. This could offset a potential decline in sales growth should consumer confidence weaken further.

Outlook

Market analysts forecast the retailer will deliver 14% earnings per share growth in fiscal 2020. Its forward price-earnings ratio of 41 is not cheap, but its strategy suggests that it could post long-term capital growth.

Disclosure: The author has no position in any stocks mentioned.

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This article first appeared on GuruFocus.