3 Growth Stocks You Should Keep Your Eyes On

Growth stocks are sometimes found in the least likely industries. While organic food is already a well-known trend, consumer staples like eyewear and donuts are also equally good hunting grounds.

Feb 21, 2014 at 11:22AM

As the world's largest eyewear company with a market capitalization in excess of $20 billion, Luxottica Group (NYSE:LUX) boasts tremendous growth potential for a company of its size. It grew its revenue and earnings by a 10-year compound annual growth rate of 8.5% and 3.8%, respectively. Luxottica's recent growth trajectory is even more impressive, having increased its top and bottom lines by a CAGR of 11.6% and 19.8%, respectively, from 2009 to 2012. Looking ahead, Luxottica's growth prospects look promising, as it benefits from two key growth drivers.

Market growth
Luxottica derives its revenue equally from the sale of both sunglasses and prescription frames and lenses. There is genuine untapped demand for both product categories, based on research from the Vision Council of America and company's internal estimates.

With respect to sunglasses, four in five American customers have less than two pairs of sunglasses. This ratio is surprisingly low, considering the number of shirts, pants, dresses, shoes, and other fashion accessories that a typical consumer will own. It is intuitive that a consumer will want to have an additional pair of sunglasses to match with his or her clothes and other fashion accessories.

There is also significant up-selling potential. Only about 20% of customers buy premium sunglasses (above $50), while 30% of them buy polarized sunglasses, a category that has been in existence since 1936. Luxottica is well-positioned to capitalize on the move toward premiumization by virtue of operating exclusively in the premium-sunglasses category. Its brand portfolio includes, among others, Ray-Ban, a prominent sunglasses brand, and Oakley, a leading sports eyewear brand. Furthermore, Luxottica estimates that it earns an additional $50 for every upgrade to polarized sunglasses.  

In the optical category, the market dynamics are equally, if not more, attractive. An estimated 20 million American adults are undiagnosed, while 25% of children are unaware of their vision problems. Unlike sunglasses, prescription eyewear is a non-discretionary consumer product, as impaired vision affects people at work, in school, and throughout their everyday lives. 

Prescription eyewear shares similar demand drivers with the growing natural- and organic-food market, as both are driven by heightened awareness of health and wellness. With an increasing emphasis on fighting obesity, preventive health, and gluten-free diets, the growth of the natural- and organic-food category has significantly outpaced that of the food-retail industry.

From 2008 to 2012, the natural- and organic-food category grew by a CAGR of 8.6% compared with 2.4% for U.S. supermarkets. Over the same period, Sprouts Farmers Market (NASDAQ:SFM) increased its revenue by a 17.1% CAGR. Spouts Farmers Market achieved this superior growth by positioning itself as a value-oriented natural- and organic-food retailer. By offering its products at a discount vis-a-vis other organic-food retailers, Spouts Farmers Market broadens its appeal to budget-conscious consumers and first-timers making the transition to organic-food diets.

A rising tide lifts all boats, and both Luxottica and Sprouts Farmer Market benefit from the underlying growth in their respective markets.

Asset-light growth 
Luxottica is moving toward a more franchising-focused strategy in a bid to grow its optical-retail operation Pearle Vision. In 2009, the split between company-operated stores and franchised locations was about 50-50. As of March 2013, franchised locations accounted for about 58% of Pearle Vision's store footprint. Luxottica has plans to add another 1,000 Pearle Vision stores in the next few years, of which the majority will be franchised.

Franchising is a win-win strategy for Luxottica and doctors (franchisees). Luxottica can grow faster without committing significant capital, while doctors focus on their core eye-care capabilities and outsource vendor relationships and lab services to Luxottica.

Another consumer company that has successfully grown via franchisees is Dunkin' Brands (NASDAQ:DNKN). With an almost 100% franchised model (less than 0.2% of stores are company operated), Dunkin' is growing rapidly. It more than doubled the number of net new U.S. Dunkin' store additions from 171 in 2009 to 371 in 2013. In 2014, Dunkin' is looking to add another 380-410 stores. From 2009 to 2012, Dunkin's revenue grew by a three-year CAGR of 7%.

Looking ahead, it has set a long term 6%-8% revenue growth target. This compares favorably with The National Restaurant Association's 2014 industry sales growth forecast of 3.6%.

Growth aside, Dunkin's asset-light franchised business model enables it to deliver an operating margin in the mid-30% range and a free cash flow margin in excess of 20%. Its industry-high margins are superior to that of its peers like Starbucks (limited franchising) and McDonald's (about 15% of stores company owned and operated).

Foolish final thoughts
For a multi-billion dollar enterprise, Luxottica has simply defied gravity by growing sales and net income at double-digit rates for the past three years. The future looks even brighter, as industry prospects and the shift toward franchising lead to even stronger growth for Luxottica.

Another top growth stock you can't ignore
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Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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