Over the past six months, Grocery Outlet has been a great trade, beating the S&P 500 by 16.2%. Its stock price has climbed to $17.15, representing a healthy 33.7% increase. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
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 Is Grocery Outlet Not Exciting?
We’re happy investors have made money, but we don't have much confidence in Grocery Outlet. Here are three reasons there are better opportunities than GO and a stock we'd rather own.
1. Weak Operating Margin Could Cause Trouble
Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.
Grocery Outlet was profitable over the last two years but held back by its large cost base. Its average operating margin of 1.4% was weak for a consumer retail business. This result isn’t too surprising given its low gross margin as a starting point.
2. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
Grocery Outlet historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 2.2%, lower than the typical cost of capital (how much it costs to raise money) for consumer retail companies.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
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 burned through $26.06 million of cash over the last year, and its $1.76 billion of debt exceeds the $55.19 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Grocery Outlet’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Grocery Outlet until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Grocery Outlet’s business quality ultimately falls short of our standards. With its shares beating the market recently, the stock trades at 20.6× forward P/E (or $17.15 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are more exciting stocks to buy at the moment. Let us point you toward the most entrenched endpoint security platform on the market.
Stocks We Would Buy Instead of Grocery Outlet
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