Executive Summary / Key Takeaways

• Strategic Turnaround Underway: Grocery Outlet is executing a focused turnaround strategy under new leadership, addressing past operational challenges stemming from an ERP system transition and over-aggressive expansion. The emphasis is on disciplined growth, optimizing returns on invested capital (ROIC), and strengthening the core value proposition.
• Technology as a Core Enabler: Key technological advancements, including the real-time order guide and new fresh category ordering tools, are driving tangible benefits like improved inventory visibility, in-stock positions, and double-digit sales lifts in test environments, bolstering the company's competitive moat.
• Solid Q2 2025 Performance: The company exceeded its Q2 2025 outlook, reporting net sales growth of 4.5% to $1.18 billion, comparable store sales growth of 1.1%, and a gross margin of 30.6%. Adjusted EPS was raised for the full year, primarily due to favorable interest expense.
• Refocused Growth & Profitability: Management projects 1-2% comparable store sales growth and 33-35 net new stores for fiscal 2025, targeting cash-on-cash returns above 20% in year 4 for recent cohorts. The aim is to achieve a 6% adjusted EBITDA margin, driven by cost efficiencies and improved operating leverage.
• Competitive Strengths Amidst Risks: Grocery Outlet's opportunistic buying model and strong store-level execution provide a unique value proposition against larger competitors, though macroeconomic uncertainties and ongoing legal/systemic risks warrant continued monitoring.

The Unconventional Grocer's Enduring Appeal

Grocery Outlet Holding Corp. is a high-growth, extreme value retailer that has carved a distinct niche in the competitive grocery landscape since its founding in 1946. Operating primarily through a network of independently operated stores (IOs), the company's business model is built on opportunistic buying, allowing it to offer quality, name-brand consumables and fresh products at prices typically 40% to 70% below conventional retailers. This "treasure hunt" shopping experience, combined with localized product offerings and personalized customer service from entrepreneurial IOs, forms the bedrock of its enduring appeal.

The company's core technological differentiator, the real-time order guide, is central to its operational agility and value delivery. This system provides IOs with immediate visibility into available inventory at distribution centers, significantly improving in-stock positions and enabling more efficient ordering. Management has noted that within focus stores, a material in-stock improvement on the top 200 items is driving roughly 200 basis points of comparable sales lift. Further enhancing this capability, a new arrival guide is slated for rollout in Fall 2025, which will expand the ordering window for IOs, facilitating better planning and opportunistic product selection. Additionally, a newly introduced forecasting and ordering tool for fresh meat and produce has demonstrated remarkable success in test stores, contributing to double-digit sales increases in these critical categories. These technological tools are not merely operational conveniences; they are foundational to GO's ability to maintain its cost leadership, enhance customer experience through consistency and freshness, and optimize margins by reducing shrink and improving the opportunistic product mix. This technological edge strengthens its competitive moat by enabling agile value delivery in a dynamic market.

In the broader competitive landscape, Grocery Outlet occupies a unique position. Its gross profit margin, at 30.41% on a trailing twelve-month (TTM) basis, stands notably higher than that of major competitors like Walmart (WMT) (25%), Target (TGT) (26%), Kroger (KR) (20%), and Costco (COST) (13%). This superior gross margin underscores the effectiveness of its opportunistic buying model, which allows it to acquire inventory at significantly lower costs. However, GO's operating profit margin (0.93% TTM) and net profit margin (0.18% TTM) lag behind these larger rivals, reflecting the impact of recent operational challenges and higher selling, general, and administrative (SG&A) expenses. While GO excels in niche discount offerings and operational agility, it trails in overall market reach, scale, and, historically, in the speed of technological integration compared to its more diversified peers. Indirect competitors, including online grocery platforms and dollar stores, primarily challenge GO on convenience or entry barriers, but often at a higher price point, reinforcing GO's value proposition.

A Period of Disruption and Strategic Reorientation

Grocery Outlet's journey has not been without its trials. A pivotal moment occurred in August 2023 with the transition to a new enterprise resource planning (ERP) system, SAP (SAP). This implementation led to "significant issues," including poor data visibility, slow system speeds, and a loss of critical tools, which severely impacted buying, inventory management, and IO efficiency through fiscal 2023 and into 2025. Concurrently, the company pursued an aggressive expansion strategy, including the acquisition of United Grocery Outlet (UGO) in April 2024, adding 40 stores and a distribution center across six new states. This period of "trying to do too much at once" exacerbated operational strains and led to a temporary "missed mark on value" as the company prioritized margin over consistent value delivery. These challenges also resulted in a material weakness in internal control over financial reporting related to IT general computer controls.

In response to these headwinds, early 2025 ushered in significant leadership changes, with Jason Potter appointed CEO, Chris Miller as CFO, and Kumar Mishra as CIO. This new leadership initiated a comprehensive "Restructuring Plan" in late fiscal 2024, which was substantially completed by Q2 2025. This plan involved a workforce reduction of approximately 40 full-time employees in Q1 2025 and the termination of 28 leases for unopened stores in suboptimal locations. The strategic reorientation emphasizes disciplined growth, optimizing ROIC, and strengthening the core value proposition.

The Turnaround Takes Hold: Q2 2025 Performance and Operational Momentum

The second quarter of fiscal 2025 demonstrated encouraging progress in Grocery Outlet's strategic turnaround. Net sales increased by 4.5% year-over-year to $1.18 billion, contributing to a first-half net sales growth of 6.5% to $2.31 billion. This growth was fueled by new store openings, bringing the total store count to 552 locations, and a 1.1% increase in comparable store sales for the quarter. The comparable sales growth was driven by a 1.5% increase in transactions, partially offset by a 0.4% decrease in average transaction size, with the timing of the Easter holiday providing a positive impact.

Profitability metrics also showed signs of improvement. Gross profit for Q2 rose 3.3% to $360.7 million, with the gross margin reaching 30.6%. While this was a 30 basis point decline year-over-year, it marked a 20 basis point sequential improvement from Q1 2025, primarily due to enhanced inventory management capabilities. SG&A expenses increased 4.2% to $336.8 million, but as a percentage of net sales, they leveraged by 10 basis points to 28.5% due to the cessation of elective commission support related to the systems conversion. Operating income for Q2 was $12.8 million, impacted by $11.2 million in restructuring charges. Despite a net loss of $18.4 million for the first half of 2025, adjusted EBITDA for Q2 remained stable at $67.7 million, with an adjusted EBITDA margin of 5.7%. Adjusted EPS for Q2 was $0.23.

Operational achievements underpin this financial momentum. The real-time order guide was fully rolled out by Q2 2025, leading to improved inventory visibility and in-stock positions. The company also expanded its private label offerings, introducing approximately 250 new SKUs by Q2 2025, including the "Second Cheapest wines" label, which capitalizes on wine industry oversupply and offers higher margins. Supply chain initiatives saw the successful consolidation to a single distribution center in the Pacific Northwest, enhancing efficiency and service. Furthermore, a model store in Oakland, California, implementing layout, signage, and merchandising enhancements, has shown a "middle single-digit lift in comp," with these improvements now being rolled out to a pilot group of stores. The company's liquidity remains robust, with $55.2 million in cash and $204.9 million in revolving credit facility capacity as of June 28, 2025, and a net leverage ratio of 1.7x adjusted EBITDA.

Strategic Outlook and Investment Thesis

Grocery Outlet's forward-looking strategy is anchored in disciplined execution and a calibrated growth approach. For fiscal 2025, the company reaffirms its outlook, projecting comparable store sales growth of 1% to 2% and the addition of 33 to 35 net new stores. This new store strategy focuses on existing and high-priority adjacent markets, with over 50% infill, aiming for cash-on-cash returns exceeding 20% in year 4 for the 2025 and 2026 cohorts combined. Gross margins are expected to be in the range of 30% to 30.5%, with adjusted EBITDA guided between $260 million and $270 million. Notably, adjusted EPS guidance was increased to $0.75 to $0.80, primarily due to lower anticipated interest rates, now projected at approximately $27 million for the year. Capital expenditures are expected to be around $210 million, net of tenant allowances, supporting new store growth, existing store upgrades, technology, and supply chain infrastructure.

The underlying assumptions for this outlook include the successful completion of the last major systems update for IOs by the end of Q3 2025, transitioning to an optimization phase in 2026. A cost reduction program is expected to yield "significant gross savings" in the second half of 2025, with "substantial net savings" in 2026. Management also anticipates continued strong engagement with IOs and a healthy opportunistic buying environment.

Despite this positive trajectory, risks persist. Macroeconomic conditions, including inflation, consumer behavior shifts, and tariffs, continue to pose uncertainties. The company faces ongoing federal securities class action and stockholder derivative lawsuits related to its ERP system transition, and the material weakness in internal controls is still undergoing remediation, though expected to be resolved by the end of fiscal 2025. These factors highlight the importance of management's commitment to "getting the fundamentals right" and maintaining "focused execution."

Conclusion

Grocery Outlet is emerging from a period of significant operational challenges with renewed strategic clarity and a strong leadership team. The company's unique value proposition, powered by its opportunistic buying model and supported by critical technological advancements like the real-time order guide and fresh category ordering tools, positions it favorably in an environment where consumers increasingly prioritize value. While the path to full optimization and sustained higher profitability requires continued diligent execution, the recent financial performance and strategic initiatives suggest a compelling narrative of resurgence. The commitment to disciplined growth, enhanced IO support, and a more efficient cost structure, coupled with the inherent strength of its gross margin profile, indicates that Grocery Outlet is well-positioned to unlock significant long-term value for its shareholders and achieve its target of a 6% adjusted EBITDA margin. The journey ahead will demand vigilance against macroeconomic headwinds and the full resolution of lingering systemic issues, but the foundational elements for a successful next chapter are firmly in place.