Natural Grocers: The Bullish Thesis Is Compelling

Summary

• NGVC has an interesting business model which should continue to provide stable cash flows.
• I believe the top line could realistically grow at 3-5% per year over the next 5 years as the company is focused on expanding the store base.
• NGVC is currently trading at ~14x LTM free cash flow, which makes it fairly priced for a long-term return above 7% per year.

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Investment Thesis

Natural Grocers by Vitamin Cottage (NYSE:NYSE:NGVC) is an attractive investment opportunity at the moment. The stock delivered mediocre returns since the company's IPO 10 years ago when compared to the S&P 500, and is now trading below its IPO price of $15 per share. However, there are good reasons to believe we are at an inflection point. NGVC is now a much better and bigger business than it used to be at IPO, and the company is continuously expanding its store base at the rate of 3 to 5% per year. Moreover, the company operates in a dynamic market that has strong tailwinds and which is likely to grow faster than the traditional grocery retail market. In terms of valuation, the company is currently trading at ~14x LTM free cash flow, which makes it fairly valued relative to peers. All in all, I believe NGVC offers a good risk-reward opportunity at the current price.

Refinitiv Eikon

Company Overview

Natural Grocers by Vitamin Cottage is a Colorado-based health food chain specialized in the retail of natural and organic groceries, dietary supplements, and natural body care products. The company also offers a range of natural pet care and food products, Household and General Merchandise. It also operates a bulk food repackaging facility and distribution center in Golden, Colorado. The Company operates 162 stores in 20 states including Colorado, Arkansas, Arizona, Idaho, Iowa, Kansas, Louisiana, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington, and Wyoming.

NGVC FY21 10-K

The Market Opportunity

The organic food market consists of sales of organic food, beverages, and related services. The production of organic food involves practices that promote ecological balance and aim to conserve biodiversity. These food products generally do not use any food additives.

The global food and grocery retail market size was valued at $11.7 trillion in 2019 and is expected to grow at a compound annual growth rate of 5.0% from 2020 to 2027. The global organic food market represents only a small fraction of it and is expected to grow at a CAGR of ~13.5% from $201.77 billion in 2020 to $380.84 billion in 2025. The main reasons behind this growth are the increasing health concerns due to a growing number of chemical poisoning cases globally and consumers becoming more health-conscious.

In the US, the organic food market is estimated at about $56.4 billion and is expected to grow at a CAGR of 4.5% to reach $70.4 billion in 2025. The main factors driving this market are the increasing awareness and growing availability through more than 20,000 natural food stores and conventional grocery stores across the country.

Investor Presentation November 2021

Business Strategy

NGVC is pursuing several strategies to continue its profitable growth:

• Expanding the store base. NGVC intends to continue expanding its store base through new store openings in existing markets, as well as penetrating new markets. In FY21, NGVC opened three new stores compared to six new stores in FY20. The company plans to open four to six new stores in FY22. Even if growth is slowing down compared to pre-2016, I am confident that unit growth can still grow at 3-5% annually going forward, which is more on less in line with the organic food market growth rate.

Investor Presentation November 2021

• Increasing sales from existing customers. In order to increase its average ticket and the number of customer transactions, NGVC plans to continue offering an engaging customer experience by providing science-based nutrition education and a differentiated merchandising strategy. The company also plans to continue to utilize targeted marketing efforts to reach its existing customers, including through the {N}power customer loyalty program. The customer loyalty program is growing fast, adding an additional 100,000 million members as of Q2 FY22, which represents a year-over-year increase of 20%.

Investor Presentation November 2021

• Improving operating margins. In recent years, the operating margin decreased and now stands at approximately 3% compared to more than 5% pre-2016. Several actions have been taken in order to mitigate this decline. For instance, NGVC expanded its private-label brand offering, which now includes grocery, dairy, frozen, bulk prepackaged products, dietary supplements, and household products. This business model is similar to Sprouts Farmers Markets. (NASDAQ:SFM), and SFM has higher margins on its private-label products. These products represented 7.2% of NGVC's total sales for FY21 and there are approximately 1,000 private-label products available at the moment.

Refinitiv Eikon

NGVC competes for consumer spending in a highly fragmented market that encompasses a wide array of food retailers including large conventional supermarkets, warehouse clubs, and small groceries. SFM competes with traditional retail giants like Kroger (NYSE:KR), Albertsons (NYSE:ACI) Whole Foods or SFM, and also with online retailers like Amazon (NASDAQ:AMZN).

The company recently published Q1 FY22 results. The business delivered a strong performance in the first quarter, with sales increasing approximately 5% YoY. Moreover, comparable-store sales grew 3.8% versus last year and 16.5% compared to two years ago. Furthermore, NGVC was able to leverage strong sales increases into higher profitability and delivered a 230 basis points improvement in operating margin, which is much for a retailer. All in all, NGVC delivered a strong quarter.

We continue to see positive operating trends as we effectively navigate a dynamic environment. Our first quarter results included net sales of $277.3 million and diluted earnings per share of $0.39, increases of 4.6% and 143.8% respectively. We were able to leverage strong sales increases into higher profitability, including a 230 basis point improvement in operating margin. Momentum remains strong across our business. Daily average comparable store sales rose 3.8%, including increases in both transaction count and basket size. On a 2-year stack basis, daily average comparable store sales increased 16.5% in the first quarter.

Kemper Isely - Co-President - Q1 2022 Results

Valuation

Based on 22.6 million shares outstanding, and a price of $14.75 per share, the company has a market cap of approximately $333 million. In this part, I have used a discounted free cash flow model to value the business. The following assumptions have been made in the model:

• Estimated free cash flow for FY22 of $29 million.
• A 4% growth rate over the next four years until FY25, which is in line with the industry's growth rate.
• A 2% terminal growth rate.
• A discount rate of 7%.

Author's DCF Model

Based on the model, I have come up with a value close to ~$22.5 per share. Given the current price, NGVC is undervalued in my opinion, and investing in this stock at the current price is likely to deliver an 8-9% annual return over the long term. Furthermore, if unit growth accelerates and margins improve, NGVC will grow even faster, which is positive for the bullish thesis.

Key Takeaways

In summary, NGVC has an interesting business model which should continue to provide stable cash flows. I believe the top line could realistically grow at 3-5% per year over the next 5 years as the company is focused on expanding the store base and improving customer engagement. In terms of valuation, the company is currently trading at ~14x LTM free cash flow. I think the stock is fairly priced for a long-term return above 7% per year.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in SFM, NGVC over 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.