Investment thesis
Our current investment thesis is:
- We are a big fan of NGVC's unique business model, positioning it incredibly well to achieve growth. Consumers are resonating well with its down-to-earth attitude and willingness to support its customers. The industry is highly competitive but NGVC has its place in the market, owing to its breadth of choice. We see a strong runway for new store growth and further brand development.
- With its performance compared to its peers already strong, this is clearly a company positioned for long-term success. At this share price, however, we do not see upside for investors.
Company description
Natural Grocers by Vitamin Cottage, Inc. (NYSE:NGVC) is a specialty retailer of natural and organic groceries, dietary supplements, and body care products. With a focus on promoting health and wellness, the company operates stores across the United States, providing high-quality products to its customers.
Share price
NGVC's share price performance has been disastrous during the last decade, losing over 50% of its value while the S&P 500 has soared. This is a reflection of its softening financial performance and a change in its long-term outlook.
Financial analysis
Presented above are NGVC's financial results.
Revenue & commercial factors
NGVC's revenue has grown at a CAGR of 11% during the last decade, with impressively consistent gains year-on-year, only slowing from FY21.
Business Model
NGVC exclusively focuses on natural and organic products, catering to a growing market of health-conscious consumers. Its commitment to quality and strict product standards has allowed it to quickly attract customers seeking wholesome and chemical-free options. There has been a clear focus on this segment of the population, contributing to a loyal customer base and active feedback. The market lacked a strong, regional, pure-play option, contributing to good growth and the development of its brand in this segment. Focus has quickly switched to attracting new customers into this lifestyle.
The company maintains stringent quality standards for the products it offers (One of its 5 founding principles). It carefully curates its inventory, ensuring that all items meet its criteria for natural, organic, and non-GMO (genetically modified organisms) certifications. A focus on health means greater scrutiny from its customers, meaning scope for brand damage if non-compliant but thus far, a good reputation.
A unique component of its business model is the provision of extensive nutritional education to customers (One of its 5 founding principles is "Nutritional Education"). It offers free in-store classes, seminars, and workshops on various health topics. Over $4m was spent in FY22 on this. Considering the long-term marketing value and community interaction this provides, the ROI is likely high in our view. Further, NGVC employs knowledgeable staff members, including health coaches and nutritionists, who can provide personalized guidance and recommendations to customers (One of its 5 founding principles). This goes significantly above-and-beyond the standard customer service, again fostering a long-term relationship with its customers.
Despite their focus on natural and organic products, Natural Grocers strives to maintain competitive pricing (One of its 5 founding principles). Its ability to offer high-quality products at reasonable prices attracts budget-conscious consumers who are looking to make a positive transition in their diets. Making healthy choices accessible to a broader audience is a key objective of the company. We like this approach as NGVC wants to avoid being too niche, but instead a mainstream alternative
This unique business model has been highly successful. NGVC has strategically expanded its store locations, broadening its customer base and growing its brand. Management continues to execute on this strategy, believing there to be a good runway in the coming years at accretive returns.
Groceries Industry
Over the last decade, there has been a significant increase in health consciousness among consumers. People are more aware of the impact of their dietary choices on their well-being, partially due to the power of information delivery through digitalization (social pressures), as well as Governmental influence. NGVC represents a "serious" option for consumers, allowing for multiple choices to be compared and a broad range of products, which is not readily available in most grocers.
In conjunction with this, the demand for organic and non-GMO products has surged. NGVC is committed to offering a wide range of certified organic and non-GMO items that align perfectly with this trend, and has shown an eagerness and willingness to adapt to changing trends and nutritional guidance.
With these factors in mind, consumers are increasingly focused on transparency and trust. Understanding nutritional guidance, particularly in personal cases and judgmental areas is not easy, contributing to a level of reliance on the retailers. NGVC's commitment to stringent quality standards, transparent sourcing practices, and providing readily available guidance instill confidence in customers. This allows for repeat business and positive word-of-mouth marketing.
When considering the company's business model and industry tailwinds, it is easy to see how investors were sold a high growth, high margins dream. The issue is saturation. The industry is highly competitive, with this competition contributing to pricing pressures in what is a commoditized industry. Key competitors include Whole Foods Market, Sprouts Farmers Market, and Trader Joe's. We do think NGVC is positioned well to operate alongside these companies, with its value being through a niche focus.
In conjunction with new store growth, industry tailwinds, and further market penetration, we believe the following two factors are key opportunities to enhance growth:
- Online Expansion - Strengthening its online platform and e-commerce presence has the potential to further democratize access to healthy options, reducing friction.
- Private Labeling - Expanding private-label offerings has the potential to improve margins and expand its relationship with customers.
Margins
A major reason for the company's share price decline is its margin progression during the period. EBITDA-M has fallen from 8% in FY13 to ~5% in the LTM period, with a significant increase in S&A spending which has offset any benefits from economies of scale through GPM.
This margin development is a concern and a reflection of increased competitive pressures in our view, owing to large brands pivoting their portfolios and new entrants. We consider this a disappointing development but understandable given the segment is still in its growth phase. It was always unlikely that these levels could be sustained by a food retailer.
Quarterly results
NGVC's recent performance has been muted, with limited deviation from its FY22/FY21 levels. Top-line revenue growth was +0.6%, +1.1%, +4.2%, and +5.8% in its last four quarters, with a small step down in margins that have stabilized in the last 2 quarters.
We attribute this performance to the company's strong value proposition, in conjunction with inelastic demand (people cannot just stop eating during difficult conditions). Its customers are those who are specifically seeking high-quality items and are willing to bear the increased costs associated with this. With tough macroeconomic conditions, it is inevitable that some consumers will trade down or reduce basket sizes, but NGVC is positioned to deliver price increases and sticky demand despite this.
Conditions will likely remain difficult in the coming quarters, which could contribute to a compounding negative impact on consumers' finances, leading to a decline in demand. This is particularly the case for new customers, who are likely disincentivized currently to improve the quality of their baskets. We expect demand to remain in the LSD range, although is unlikely to fall flat, particularly as new locations are opened.
Key takeaways from its most recent quarter are:
- Comparable store sales appear to be accelerating, with a +4.4% growth rate, including a +1.9% increase in daily average transaction count. This implies the bottom may have been reached, although we are hesitant given the wider industry outlook.
- Management is seeing growth continue to be driven by its existing customer base, which although is positively showing resilience, new customer uptake is lacking.
- Margin improvement has been achieved through operational improvements.
- Looking more broadly, the company's business plan is delivering, with a +19.1% increase in daily average comparable store sales compared to Q3'19. The value proposition is clear, the question is more so if the market is large enough for what investors expected.
Balance sheet & cash flows
NGVC's balance sheet is broadly clean. The company has a ND/EBITDA ratio of 3x, although most of this relates to capital leases. Inventory turnover has worsened in recent months, not substantially but given its slim FCFs, this has contributed to small cash returns. This is an inherent issue with the groceries segment, which is not highly profitable and is capital intensive (Capex is ~3% of revenue).
Despite this, the company has consistently operated with a strong ROE, which implies its national expansion across the US is consistently profitable. Again, the business is performing as it likely should be, with the share price performance potentially reflecting incorrect investor expectations.
Industry analysis
Presented above is a comparison of NGVC's growth and profitability to the average of its industry, as defined by Seeking Alpha (12 companies).
NGVC performs well relative to its peers, particularly given its size. The company's revenue growth has exceeded its peers on a 3Y and 5Y basis, as well as in several profitability metrics. We attribute this to its current strategic focus, with a consistent healthy increase in new locations, as well as industry tailwinds toward higher-quality goods.
Further, NGVC's margins are broadly in line with its peers. Given the company is operating in a niche, the expectation would be for it to exceed this average, but the value from significant scale is far more important. The net impact is parity with the industry, which we consider good.
Valuation
NGVC is currently trading at 11x LTM EBITDA and 10x NTM EBITDA. This is a discount to its historical average.
A discount to its historical average is appropriate in our view, primarily due to its slowing revenue growth following FY18, its decline in margins, and the increased competition faced. The existing discount is minimal at an EBITDA level, suggesting further downside.
Additionally, NGVC is currently trading a ~7% premium to its peers on a LTM EBITDA basis and ~12% on a NTM P/E basis. We believe a small premium is justifiable, owing to the industry tailwinds it is facing, as well as the scope for superior growth through stores and margin improvement through scale. This implies no upside at the current share price.
As the following illustrates, NGVC's valuation has trended down during the last decade, as the company has normalized toward the valuation of its peers. With the company close to this level currently, we suspect a flattening will occur. This said, the risk remains that a further downward trajectory occurs.
Key risks with our thesis
The risks to our current thesis are:
- [Upside] Continued consumer shift toward healthy living, contributing to an acceleration in growth.
- [Upside] Effective online strategy, contributing to an omnichannel approach and reduced barriers to customers.
- [Downside] Economic downturn impacting consumer spending, slowing its growth trajectory.
- [Downside] Intensified competition eroding market share.
Final thoughts
We really like the NGVC business model, with its share price performance between 2012-2016 a reflection of incorrect investor understanding of what it can be. Its differentiation and alternative approach have allowed the company to enter and grow within a highly competitive industry, but its inherent nature means NGVC is very unlikely to exceed the broader growth rate organically (/comparably).
With a good comparable performance relative to its peers and industry tailwinds remaining strong, we consider this a good investment within the industry in the years to come. This said, at its current price, we do not see upside.
Welbeck Ash Research
Our intention is to provide insightful research and new ideas, through deep bottom-up business analysis. We look to tell a story and identify the hallmarks of long-term quality. We are not swayed by the emotions of market sentiment and short-term desires.“Day to day, the stock market is a voting machine; in the long term it’s a weighing machine.”
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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