It’s been a choppy year for the major market averages and we’ve seen quite bifurcated returns across sectors.
Several tech stocks are putting up solid returns, energy is struggling to gain any traction, financial stocks are being hit hard due to fears of bank runs, and defensive stocks are continuing their outperformance that began last year.
While the latter group is a go-to option in more challenging periods for the market due to its lower beta and perceived safety, several names in the group are becoming expensive after a year of outperformance.
This has made allocating capital to staples and grocery stocks more difficult, with some names like Sprouts Farmers Market (SFM) sitting at all-time highs.
Fortunately, there are some defensive names that are still on the sale rack.
Not only is this stock down nearly 40% from its 2022 highs, but it’s continued to trade in a range since its IPO debut despite steady growth in annual EPS.
Given the continued growth and the company’s ability to outperform in recessionary periods, I believe it’s only a matter of time before this stock makes new all-time highs above $48.00 per share and I see this violent pullback as an opportunity to start a position in this mid-cap growth stock.
Defensive Name Still On Sale
Grocery Outlet Holding Corporation (GO) is a $2.8 billion stock in the grocery industry group that operates ~450 stores in the United States and has grown its annual EPS from $0.17 in FY2017 to $1.02 last year.
The company believes it can ultimately grow to a store count of ~4,800 stores domestically given its considerable whitespace with its stores concentrated in the Western United States with a small footprint in the Northeast (32 stores).
It differentiates itself from other grocers by consistently having prices 40% below other retailers on its best deals, and its changing SKUs make shopping at Grocery Outlet Holding Corporation’s stores a treasure hunt-like experience, similar to why many consumers gravitate to Ollie’s Bargain Outlets (OLLI) which has also seen significant unit growth over the past decade.
However, while the recessionary environment should have been Grocery Outlet’s opportunity to shine given that many consumers were trading down, the stock outperformed massively in H1-2022 with a 40% return but came into Q3 2022 much less attractively priced at over 40.0x earnings.
This meant that the stock struggled to hold onto its gains despite a solid Q3 and Q4 report, with comparable sales up 15% in Q4 and net sales up 19% year-over-year.
However, there were headwinds from product and supply chain costs, and while the purchasing and planning team helped to mitigate this, we did see a minor hit to earnings due to higher interest costs and slightly weaker sales performance than some analysts were expecting.
Looking ahead to FY2022, Grocery Outlet expects to open 25 to 28 stores which is slightly below its long-term target of ~10% growth, and it’s guided for net sales of $3.90 billion at the top end of guidance which would represent just 8% year-over-year.
This has contributed to the volatility in the stock with this representing a deceleration from the double-digit sales growth that investors enjoyed in previous years.
That said, I see the largest contributor to the share price weakness (~40% correction from its highs) being the fact that the stock was priced for perfection at $46.00 per share, meaning that the stock was due to decline regardless of the results it put forth.
The good news is that the stock is now more reasonably valued and estimates look more conservative, suggesting the potential for Grocery Outlet to over-deliver on expectations.
The Fundamentals
Based on a current share price of $29.20 and FY2024 annual EPS estimates of $1.13, Grocery Outlet trades at ~25.8x next year’s earnings which is not all that cheap relative to some of the values available elsewhere in the market.
However, this is a stock that has historically traded at ~35.0x earnings, leaving it trading at a deep discount to its historical multiples.
So, while it may not represent a relative value compared to other retail names like MarineMax (HZO) at just ~6.0x earnings, this is the cheapest the stock has been since Q3 2021 which prompted an 80% plus rally in the stock over the next year.
As for its earnings outlook, Grocery Outlet isn’t expected to see growth in annual EPS this year ($0.94 vs. $1.02), annual EPS should increase materially in FY2024 based on annual EPS estimates of $1.13.
And when it comes to the long-term picture, the company has considerable whitespace in the United States and has performed better than nearly all of its retail peers in past recessionary periods from a same-store sales standpoint.
So, for investors looking for an investment with a defensive tilt in case we do head into a worse recession than some expect, I see Grocery Outlet as a growth at a reasonable price option below $29.00.
The Technical Picture
Grocery Outlet may not look like the most exciting story at first glance given that the stock has been locked in an intermediate downtrend since September 2022 and has struggled to make any real progress since its IPO debut in Q2 2019.
However, while the stock is below declining 100-day and 200-day moving averages, the stock appears to be trying to hammer out a bottom with a series of higher highs and higher lows since March and a slight change of character relative to past rallies that immediately failed, such as those in October and February.
See the Full Technical Analysis Report for GO
In addition, the stock is now back above its 50-day moving average and has reclaimed broken support at $28.50.
The reclamation of the 50-day moving average and broken support are positive developments as is the fact that capital continues to gravitate towards defensive stocks given the more challenging economic environment.
Plus, given the challenging economic environment, Grocery Outlet should continue to benefit from trading down given that its prices are consistently up to 40% below that of conventional retailers.
So, if the stock can put together a solid Q1 earnings report when it reports next month, I would not be surprised to see the stock make a run at the $32.00 level before summer.
The Bottom Line
Based on what I believe to be a conservative multiple of 33.0x earnings (5% discount to historical average) and FY2024 annual EPS estimates of $1.13, I see a fair value for Grocery Outlet of $37.30, pointing to a 28% upside from current levels.
I see this as an attractive upside for a growth story in the staples category that can diversify one’s portfolio and smooth out portfolio volatility.
There looks to be significant long-term upside here given management’s belief that it has the potential to operate ~4,800 stores domestically (10x current store count).
So, with GO down ~40% from its highs, I see this pullback to $29.00 as an attractive entry point.
Disclosure: I am long HZO
The above analysis of Grocery Outlet Holding Corporation (GO) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Is Grocery Outlet Holding Corporation (GO) A Buy or Sell?
Based on MarketClub’s technical analysis tools, Grocery Outlet Holding Corporation (GO) is showing signs of short-term weakness, but still remains in the confines of a long-term uptrend. Keep an eye on GO as it may be in the beginning stages of a reversal.
MarketClub is analyzing every data tick, ready to spot a new trend as it develops.
Get an alert when GO triggers a new signal and analysis for over 350K markets with a 30-day MarketClub trial.
