This Specialty Grocer Is More Attractive Than Its Larger Peers

Size (or the lack of it) of a company isn't the biggest factor in picking a stock. In Natural Grocers' case, its smaller store format actually works to its advantage.

Jun 6, 2014 at 9:00AM

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Source: Natural Grocers.

According to the Nutrition Business Journal, domestic sales of natural & organic food and dietary supplements have grown rapidly since the turn of the century. Natural & organic food sales in the U.S. rose by a 10-year CAGR of 12.3% from $13 billion in 2000 to $41 billion in 2010; while the domestic dietary supplements market increased revenues by an annualized rate of 5% to reach $28.1 billion in 2010.

The natural thing to do is to buy the largest players in these categories such as Whole Foods Market (NASDAQ:WFM), GNC Holdings (NYSE:GNC), but this might not be the most profitable way to benefit from these food trends. Natural Grocers by Vitamin Cottage (NYSE:NGVC), a specialty grocer of natural and organic groceries and dietary supplements, could be an equally good, if not better, proxy.

Small is the new big
Natural Grocers' average store size is approximately 10,000 square feet, compared with 38,000 square feet for an average Whole Foods store. With respect to relative size in terms of top line, Natural Grocers' sales are only approximately 3% of Whole Foods revenue.

For Whole Foods, it leverages its large store size to provide as many customer-friendly features as possible. For example, most of its stores are equipped with sit-down eating areas and customer service booths staffed with specialized employees, unlike other grocers, which try to maximize their floor space by packing in the maximum amount of SKUs. Whole Foods has also brought the customer shopping experience to a new level in a number of its stores by incorporating wine bars and massage chairs.

Natural Grocers has gone on a different way and is positioned as a provider of high-quality products at affordable prices. There are several advantages associated with Natural Grocers' smaller store format.

First, Natural Grocers is more economical with its floor space usage, boasting a similar number of SKUs to Whole Foods Market, despite having an average store size almost one-quarter of that of Whole Foods Market. An average Natural Grocers store carries 20,000 SKUs, compared with 21,000 SKUs for Whole Foods.

As a result of its efficient usage of floor space, Natural Grocers enjoys strong new store economics. Its new stores typically pay back the original capital investment in four years, and register 35% cash-on-cash returns by the end of the fifth year of operations.

Secondly, its smaller store format means that it's easier to find suitable locations and expand faster. Natural Grocers' stores are found in many off-beat locations. Its Norman store is located at the edge of a regional retail center anchored by a supercenter; while its Boulder store shares a parking lot with a Whole Foods.

The results speak for themselves; using return on invested capital (ROIC) as a measure of profitability. Notwithstanding the disparity in scale between the two, Natural Grocers' 2013 ROIC of 13% is comparable with Whole Foods 14.3% ROIC.

Cross-selling
The lines between different retail formats have been blurring. More appliance retailers are selling furniture products, an increasing number of pharmacies are including general merchandise, and grocers aren't just offering groceries anymore. Therefore, it makes sense for retailers to broaden its product offerings to increase the average transaction size per customers. This is especially true if the new products are synergistic.

In the case of Natural Grocers, it derived 25% of its fiscal 2013 sales from dietary supplements. Natural Grocers is obviously benefiting from the fact that its health-conscious customers are likely to be interested in both natural and organic groceries and dietary supplements. As a result, Natural Grocers has engaged in cross-selling efforts to convert its occasional, single-category customers into core, multi-category customers.   

Similar to Natural Grocers, GNC is a firm believer in the power of cross-selling. About 25% of its vitamins-purchasing customers buy sports nutrition products; and 50% of its sports nutrition customers purchasing vitamins. In April last year, GNC offered its new customer loyalty program, 'Member Price Program' free to anyone who signed up before June 24 2013. With an enlarged member base, GNC has the ability to better target its cross-selling efforts with its existing customers.

Foolish final thoughts
As a validation of its competitive advantages in its small size and cross-selling capabilities, Natural Grocers has delivered outstanding financial results in recent years. It achieved positive comparable-store-sales growth for 47 consecutive quarters and grew its top line at a CAGR of 27.6% from fiscal 2011 to fiscal 2013.

Looking ahead, Natural Grocers plans to add 15 units to its current network of 83 stores. It sees the long term potential for 1,100 Natural Grocers stores, including approximately 225 additional stores in the 15 states where it currently operates. This suggests a significant growth runway for Natural Grocers.  

Will this stock be your next multi-bagger?
The best company to invest in as a proxy for a growing trend is rarely the largest company in the sector. Natural Grocers is potentially a better investment candidate than Whole Foods Market. Give us five minutes and we'll show how you could own the best stock for 2014. Every year, The Motley Fool's chief investment officer hand-picks one stock with outstanding potential. But it's not just any run-of-the-mill company. It's a stock perfectly positioned to cash in on one of the upcoming year's most lucrative trends. Last year his pick skyrocketed 134%. And previous top picks have gained upwards of 908%, 1,252% and 1,303% over the subsequent years! Believe me, you don't want to miss what could be his biggest winner yet! Just click here to download your free copy of "The Motley Fool's Top Stock for 2014" today.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. 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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