Could Natural Grocers by Vitamin Cottage Be the Next Big Player in Organic Food?

A new Natural Grocers by Vitamin Cottage under construction in Spokane, Wash. Image by Nicholas Rossolillo.

Americans have changed their grocery shopping lists. In recent years, the trend toward natural and organic food has been huge. Even Wal-Mart (WMT -0.49%) has gotten into the space. There are several well-known stocks that offer investors a piece of the organic pie, but what about the lesser-known Natural Grocers by Vitamin Cottage (NGVC 0.47%)? 

Who is Natural Grocers?
Natural Grocers is a small grocer based in Lakewood, Colo., that specializes in "natural and organic groceries and dietary supplements." The company has 108 stores across 19 states, which makes it quite a bit smaller than three of its direct, publicly traded organic competitors: The Fresh Market (TFM), Sprouts Farmers Market (SFM 1.06%), and Whole Foods(WFM). The company also trails its larger peers in enterprise value, a way of measuring how much a business is worth, and revenue. Both of those metrics for Natural Grocers are less than half of The Fresh Market's, its nearest competitor in terms of size. Here is a basic overview of those metrics:

Chart data source: Yahoo! Finance.

Is Natural Grocers the next big thing?
With healthy and natural eating en vogue, should investors be excited about this small chain? Let's consider profit margin and a simple metric derived from the previous chart: revenue per store.

Data source: Yahoo! Finance.

Whole Foods has found a way to get the most revenue out of each of its locations, with everyone else trailing by a large distance. The larger grocery chains are also running an average profit margin around 3.5%, while Natural Grocers is at only 2.5%. From this standpoint, increasing store sales through advertising and driving traffic with sales incentives are two methods Natural Grocers could exploit to improve revenue and profitability. The company has begun to employ initiatives to do this. For example, as noted in the last earnings conference call, the store's {N}power program, a digital coupon and rewards initiative, has been aggressively marketed at checkout registers. Natural Grocers also just completed its first national storewide sales initiative, and has more of them planned for the rest of the year. Kemper Isley, co-president of the company, noted on the call that the expectation is that customers will "increase their average basket size pretty substantially" as a result of the increased advertising.  

While the company is attempting to increase sales at existing stores, its main plan for growth is new store openings. All of the chains mentioned have been growing their number of stores over the past few years. And what plans are there for future expansion?

Data source: company-specific quarterly earnings reports.  

Natural Grocers' store growth in the past year was 18%. This figure compares with 11%, 14%, and 7% for The Fresh Market, Sprouts Farmers Market, and Whole Foods, respectively. The smaller chain's expected openings in the year to follow are also more aggressive, sitting at 21%. The company's plan is to keep this roughly 20% annual store opening rate going for five years. This plan explains a reason for the slighter profit margin compared with larger peers, as new stores cost money to open.

While aggressive new store growth is exciting, it is important to consider how the company will fund this growth. Natural Grocers' long-term debt-to-equity ratio is at 0.44. By comparison, The Fresh Market sat at 0.27 before the announced purchase by Apollo Global Management, while Sprouts Farmers Market is at 0.45, and Whole Foods is 0.53.

With its substantially lower amount of debt compared with others operating in the organic grocery business, we can see one of the reasons The Fresh Market was an attractive buyout target. While Natural Grocers is certainly growing locations by leaps and bounds, the burden of interest expense from financing raises questions about how sustainable that plan is.

One could argue that the aggressive expansion will eventually pay off for investors, as Natural Grocers continues to expand its footprint and offer an alternative to grocery shoppers. But I have my doubts that this can continue long term. Noted in the last quarter conference call was that same-store sales increases continue to come in below management's expectations. Q1 saw comps increases by 3.6%. For the coming year, management sees comps coming in the low end of its 5%-7% guidance. If this trend continues, I would expect the company to slow down expansion and focus efforts on driving sales to existing stores.

Foolish thoughts
Is Natural Grocers an up-and-coming household name in the grocery business? Management is trying to make that happen with an aggressive plan to expand and keep up with bigger chains, but I'm not ready to buy in. The company is in a competitive market with large and well-entrenched competitors. Having taken on substantial liabilities with a store model that underperforms in its ability to bring in revenue, it may not set the grocery industry on fire. I see growth plans slowing down in the next couple of years, as I believe company management will need to focus efforts on developing sales at existing locations. Investors looking for a high-growth opportunity in the years to come might want to look elsewhere.