Natural Grocers: Executing On Margins, But Decelerating Growth Needs To Be Monitored

My last write-up on Natural Grocers (NYSE:NGVC) was generally positive, as I expected to see the company’s efforts to boost the in-store assortment (especially supplements) and its loyalty program pay off in higher sales, not to mention the company’s very competitive price position versus rivals like Sprouts (SFM) and Whole Foods (owned by Amazon (AMZN)). Since then, the shares are up more than 30% - not a bad return and a little better than that of Sprouts.

I’m not quite as bullish at this point, though. Traffic has started decelerating at the stores, comps are getting more challenging for the supplements business, and I’m concerned about more challenges to margins given those traffic trends. I still see Natural Grocers as capable of high single-digit revenue growth over the long term with improving margins, but with fair value in the high teens, I don’t see quite the same upside at this point.

 

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Natural Grocers: Executing On Margins, But Decelerating Growth Needs To Be Monitored

Natural Grocers Hit By Transitional Turbulence

 

The last six months have been rough for Natural Grocers by Vitamin Cottage (NGVC) (“Natural Grocers”), as a quick reversal in same-store comps, inflation, supply chain challenges, and challenges in opening new stores drove a big drop in the share price after fiscal second quarter earnings, a drop that the shares have yet to recover from despite some solid two-year comp stacks and evidence of stabilization/normalization in the business.

Down more than 25% since my last update, this call has clearly not worked, with Natural Grocers shares lagging comps like Sprouts (SFM) and United Natural Foods (UNFI) (a distributor, not a store operator). I’ve revised my numbers lower, but high single-digit long-term revenue growth (driven by both new store openings and same-store sales) and low single-digit FCF margins can support a higher price than what the market is showing today.

 

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Natural Grocers Hit By Transitional Turbulence

Natural Grocers Seeing Stronger Customer Loyalty, Better Margins

Stocks viewed as defensive relative to the pandemic have started seeing some weakness of late, but Natural Grocers by Vitamin Cottage (NGVC) (“Natural Grocers”) has been holding up very well, rising almost 30% since my last article and outperforming grocery store peers since the election by a comfortable margin (from 20% outperformance to Sprouts (SFM) to over 30% outperformance to Kroger (KR) and Royal Ahold (OTCQX:ADRNY).

I like Natural Grocers back in late August, but I thought there’d be a better opportunity to buy, and the shares did fall another 20% or so before bottoming out and rallying on good quarterly comps-store growth and gross margin numbers. The margins in particular have impressed me, particularly with Natural Grocers able to maintain their positive pricing gaps with Sprouts and Amazon’s (AMZN) Whole Foods.

I have more confidence in Natural Grocers now than I did in late August, and I like the company’s more deliberate pace of store expansion. I also like margin-improving decisions like expanding its alcohol assortment, as well as the positive momentum in the rewards program. I can see these shares heading toward $20, though I do still have lingering long-term concerns on gross margins.

 

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Natural Grocers Seeing Stronger Customer Loyalty, Better Margins

Better Execution At Natural Grocers Counterbalanced By A Tougher Operating Environment

These are tough times to be in the grocery business. With intensifying competition from newer entrants like Aldi and Lidl, steady pressure from Walmart (WMT), and growing online sales, it's hard for everybody, and it's even harder for organic/natural-focused grocers like Natural Grocers (NGVC) and Sprouts (SFM) as "regular" grocers increase their organic assortment and continue to pressure pricing.

Natural Grocers shares have fallen 40% since my last update, and the company is now largely uncovered (two analysts currently have published estimates). While the company has not done quite as well as I'd hoped six months ago in terms of boosting margins, it looks like a tough macro and a negative sentiment toward the sector has more to do with the underperformance. I do see the shares as undervalued now, but the grocery space is getting more and more challenging, and Natural Grocers has relatively less room for swallowing higher COGS than its peers/rivals.

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Better Execution At Natural Grocers Counterbalanced By A Tougher Operating Environment

Strong Comps And Surprisingly Good Operating Leverage Driving Natural Grocers

Natural Grocers by Vitamin College (NGVC) (or “Natural Grocers”) is doing a very good job of answering criticisms that its improved comp sales performance is only a byproduct of margin-compromising price cuts. With more effective promotional activity, restrained store expansion, and appealing operating expense leverage, Natural Grocers has seen not only an improvement in comps but also in margins, driving the shares up 20% since late June.

There are still some operating challenges at Natural Grocers, including ongoing competitive footprint expansions from Amazon’s (AMZN) Whole Foods, Sprouts (SFM), and similar retailers, and I wouldn’t completely ignore the risk of lower oil prices undermining key operating areas like Colorado and Texas. Still, Natural Grocers is managing this strategy shift more adroitly than I’d expected, and an upgraded outlook for EBITDA growth supports a higher fair value.

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Strong Comps And Surprisingly Good Operating Leverage Driving Natural Grocers

Natural Grocers Up On Strong Traffic, But Margin Follow-Through Is Crucial

I thought Natural Grocers by Vitamin Cottage (NGVC) ("Natural Grocers") held some appeal for more risk-seeking investors back in February, as the company's decision to "reinvest" in lower prices seemed likely to spur improving comps. The shares have done exceptionally well since then, with the shares shooting up about 70% since fiscal second quarter earnings in early May on the strongest comps in roughly four years and less gross margin pressure than feared.

As is often the case with low-margin business models, even small changes in margin modeling assumptions can drive big changes in the resulting fair value. I'm still skeptical that Natural Grocers can recapture the margins they're giving up to bring traffic in through the door; while using price to get people familiar with the brand isn't a terrible idea, I believe price-conscious shoppers are liable to leave if and when management tries to raise prices. Although Natural Grocers could offset its pricing action with more back-office efficiency, I think the company's modest scale works against it, and I think the risk/reward trade-off is much more balanced now than before.

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Natural Grocers Up On Strong Traffic, But Margin Follow-Through Is Crucial

Buying Traffic Has Hammered Natural Grocers' Results

When I last wrote about Natural Grocers (NGVC) roughly 18 months ago, I said that I believed the shares would continue to head lower if the company couldn't reverse weak traffic trends. Management has in fact struggled to revive store traffic, and the shares are 50% lower now. Although the company is making decisions that make sense from a long-term perspective (getting more aggressive on price to drive traffic, reorienting marketing around what makes the stores different, and significantly reducing new store openings), it is still very much an open question as to whether Natural Grocers can find the right mix that will bring back traffic and allow for worthwhile margins.

I believe this latest disappointment (after fiscal first quarter earnings) has pushed the shares down to an interesting level, but there are outsized risks here. A multiple of 6.5x my 2018 EBITDA estimate will support a fair value around $8, and my DCF model suggests an even higher target, but models are not guarantees - there's a reason one of the most common words in conjunction with "earnings" is "surprise" - and this is a risky call at this point.

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Buying Traffic Has Hammered Natural Grocers' Results

Can Natural Grocers Become A Quality Growth Company Again?

The last year hasn't been good for the wholesale/retail side of the "healthy eating" trend, but Natural Grocers by Vitamin Cottage ("Natural Grocers") (NYSE:NGVC) has done far worse than most. Shareholders in Whole Foods (NASDAQ:WFM) and United Natural Foods (NASDAQ:UNFI) are looking back at double-digit share price declines over the past year, but Natural Grocers is down 50% over that time and down about 40% since my last update on the retailer.

At this point, the company has to improve its comps if only to achieve some fixed cost leverage. It would also seem to be a good idea to slow down new store openings to a point where it can self-fund, but then that would eliminate a lot of the near-term growth potential given that the comps are pretty weak. Complicating matters further, new marketing initiatives should help stimulate those comps, but of course these initiatives cost money and have their own impacts on margins.

It's tempting to erase this company from my notes and spreadsheets and move on. There's more and more competition in the healthy eating space, and I have to wonder how much of Natural Grocers' past growth was boosted by the windfall of higher energy prices in markets like Texas and Colorado. The potential for this stock to come back is there, but it's hard for me to be excited about the shares unless and until traffic growth starts making a meaningful contribution to comps again.

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Can Natural Grocers Become A Quality Growth Company Again?

Seeking Alpha: Natural Grocers Needs Some Growth Hormones For Store Traffic

Natural Grocers by Vitamin Cottage (NYSE:NGVC) (or "Natural Grocers") may not have the same image issues as Whole Foods (NASDAQ:WFM) (aka "Whole Paycheck") or cause the same consternation with the crunchiest of organic food shoppers - Whole Foods, Sprouts (NASDAQ:SFM), and Fresh Market (NASDAQ:TFM) do all sell some conventional products - but it does have its challenges. In a market where organic/natural food is becoming more and more mainstream, alternative destinations like Trader Joe's, Kroger (NYSE:KR), and Target (NYSE:TGT) continue to represent ongoing threats to Natural Grocers' traffic and growth plans.

These share are down another 20% from where I last left them, which isn't too good next to Sprouts or Whole Foods, but isn't too awful next to Fresh Market or United Natural Foods (NASDAQ:UNFI) (a wholesaler and distributor of organic and natural foods). Unfortunately, weak comps remain a key issue with the company and the stock, as sub-5% comps just don't get the job done in terms of long-term sales per store and margin leverage.

At these levels, I'm getting more interested in the shares. I do believe the disappointing comp traffic growth is a serious threat to the long-term bullish argument, but I also think that Natural Grocers has an attractive and defensible business plan that can still work.

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Natural Grocers Needs Some Growth Hormones For Store Traffic

Seeking Alpha: In A Fierce Food Retail Market, Natural Grocers Has To Perform Better

Back in February, I had concerns that Natural Grocers by Vitamin Cottage (NYSE:NGVC) (or "Natural Grocers") shares were running a little ahead of themselves on hopes that the company was past the competitive pressures of new store entries into key markets. The shares have fallen 18% since then, as the company's respectable same-store sales growth has continued to come in a little lower than sell-side expectations and concerns about the economy and competition won't go away.

I believe there is a credible argument to be made that Natural Grocers shares are undervalued, but there is a lot of risk attached to the calculation. The company will very likely continue to generate negative free cash flow for three to four years, and the big improvements in free cash flow are well down the line. Add to that the intense competition in the natural/organic food space (arguably getting worse), and this is not exactly a can't-miss prospect.

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In A Fierce Food Retail Market, Natural Grocers Has To Perform Better

Seeking Alpha: Natural Grocers' Comps Recovering, But Can It Last?

Natural Grocers By Vitamin Cottage (NYSE:NGVC) ("Natural Grocers") had a rough time of it in 2014 as competition, particularly from Trader Joe's, had a very real impact on same-store growth and investors' previously boundless enthusiasm for natural/organic finally found some boundaries.

The underlying story at Natural Grocers hasn't changed all that much, though, and the company has still penetrated less than 10% of its theoretical footprint. Investors can rightly question whether shoppers will continue to flock to stores like Natural Grocers, Whole Foods (NASDAQ:WFM), and Sprouts (NASDAQ:SFM), particularly as conventional grocery stores/supermarkets increase their organic/natural product selections, but the same can be said for many aspirational/luxury goods (nobody *needs* a Coach bag or Starbucks latte). If Natural Grocers can continue to create a shopping experience that resonates with its core target market, I don't see the shares as unreasonably expensive.

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Natural Grocers' Comps Recovering, But Can It Last?

Seeking Alpha: Competition And Momentum Reversal Hammer Natural Grocers

Owning a popular momentum stock can be a thrill ride, but if and when the company stumbles (and most growth companies do stumble at least once), the thrills turn to chills as investors stampede to the exit. Such is the case lately for Natural Grocers by Vitamin Cottage (NGVC) ("Natural Grocers"), where the shares have lost more than half of their value in less than three months.

While the drop at Natural Grocers has certainly been accelerated by a disappointing same-store sales figure for the fiscal second quarter, this has been a lousy stretch lately for comps and peers within the natural/organic food space like Whole Foods (WFM), Sprouts (SFM), and The Fresh Market (TFM). I think it's much too early to say that Natural Grocers is done as a growth concept, but it may take a while for institutions to come back to the segment.

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Competition And Momentum Reversal Hammer Natural Grocers

Seeking Alpha: Natural Grocers Still Looks Like An Unnatural Growth Opportunity

In the five or so months since I wrote about Natural Grocers by Vitamin Cottage (NGVC), and suggested that growth-oriented investors should check out this emerging organic/natural foods retailer, the shares have climbed a solid 25%. That's not bad relative to the approximately 10% gain in the S&P 500, the slightly lower gain in Whole Foods (WFM), or the very disappointing performances of The Fresh Market (TFM) and Sprouts (SFM). What's even better is that Natural Grocers' underlying financial performance continues to validate a call that this is a solid growth stock for investors to consider.

Natural Grocers is only about 6% along its path to a 1,100-store national footprint. What's more, the company is still too small to really benefit from better pricing from distributors and leveraging its own private label brands. Plenty can still go wrong along the path towards being a "next Whole Foods", and this is by no means a safe stock, but the growth potential can support a fair value in the neighborhood of $40 to $45 today.

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Natural Grocers Still Looks Like An Unnatural Growth Opportunity

Investopedia: The Fresh Market Can't Put Margin Worries To Bed

As I wrote a quarter ago, The Fresh Market (NYSE:TFM) is a highly-valued growth stock in the food retail space, and one where the company is starting to see some real pushback from the market as to the company's margin structure and competitiveness. I didn't expect all of the concerns to get resolved in one quarter, but the company's willingness to increase promotions and accelerate store builds seems to be exactly what the Street does not want to hear right now. As I suspect there's a good chance of these shares getting even cheaper, investors may want to keep on eye on this name as a growth stock increasingly trading at a reasonable valuation.

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Investopedia: Will Less Scarcity Value Harm Whole Foods?

Whole Foods (NYSE:WFM) is still most commonly identified as the supermarket for organic, natural, and healthier foods. While plenty of shoppers know about chains like Sprout's (NYSE:SFM), Natural Grocers (Nasdaq:NGVC), and The Fresh Market (NYSE:TFM), just about everybody has been to a Whole Foods once. With more organic/healthy food options in the stock market, not to mention a significant expansion at conventional retailers like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), just how special is Whole Foods anymore? While the numbers continue to support the notion that Whole Foods is an uncommonly well-run retailer with considerable growth potential, it's increasingly challenging to justify the price on the shares.

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Seeking Alpha: Natural Grocers Boldly Going Where Others Have Gone Before

If imitation is the sincerest form of flattery, Natural Grocers (NGVC) (also known by its full name of Natural Grocers by Vitamin Cottage) is paying some big compliments to Whole Foods (WFM), The Fresh Market (TFM), Trader Joe's and Sprouts. The company is pursuing a growth strategy in the organic/natural food retailing sector that seems to be taking some of the best ideas of these larger chains and coupling them with an even tighter focus on the hard-core healthy eating community. While these shares have had a big run in 2013 and sport pretty robust valuation multiples, it may be hasty to assume that the stock is overpriced today on a long-term basis.

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Natural Grocers Boldly Going Where Others Have Gone Before