Grocery Outlet Holding Corp. (NASDAQ:GO) is a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. The company's flexible buying model allows it to offer quality, name-brand opportunistic products at prices generally 40% to 70% below those of conventional retailers. Entrepreneurial independent operators ("IOs") run Grocery Outlet's stores and create a neighborhood feel through personalized customer service and a localized product offering.

Financials

In fiscal 2023, Grocery Outlet reported annual net income of $79.4 million, annual revenue of $3.97 billion, annual operating cash flow of $303.4 million, and annual free cash flow of $111.5 million. For the first quarter of fiscal 2024, the company reported net sales of $1.04 billion, a 7.4% increase from the prior year period. Comparable store sales increased 3.9% in the quarter, driven by a 7.0% increase in the number of transactions, partially offset by a 2.9% decrease in average transaction size.

Grocery Outlet's business model and value proposition continue to resonate with customers, as evidenced by the company's strong sales growth. However, the company faced operational and financial challenges in the first quarter of fiscal 2024 due to the implementation of new technology platforms in late 2023. These system upgrades resulted in disruptions to the company's business operations, including ordering and inventory issues, as well as payment processing challenges, which adversely impacted the company's results of operations.

Despite these short-term challenges, Grocery Outlet remains confident in the long-term growth potential of its business. The company is focused on resolving the remaining system integration issues, improving data visibility and functionality, and enhancing process efficiencies. Grocery Outlet expects the financial impact of these system-related challenges to be largely contained to the second quarter of fiscal 2024, with margins and profitability expected to revert to more normalized levels in the second half of the year.

Business Overview

Grocery Outlet operates a network of 474 stores across nine states as of the end of the first quarter of fiscal 2024, including 40 stores acquired through the recent acquisition of United Grocery Outlet. The company's stores are located primarily in California, Washington, Oregon, Pennsylvania, Idaho, Nevada, Maryland, New Jersey, and Ohio. Grocery Outlet's flexible buying model and entrepreneurial IO structure allow the company to offer a constantly changing selection of quality, name-brand products at extreme discounts.

Grocery Outlet's IOs are responsible for selecting the majority of the merchandise that is consigned to their stores, based on their knowledge of local customer purchasing trends and preferences. The company provides the merchandise to the IOs on consignment, and the aggregate net sales proceeds from merchandise sales belong to Grocery Outlet. In turn, the company pays each IO a commission based on a share of the gross profit of the store.

The company's ever-changing selection of offerings across diverse product categories, including perishable and non-perishable goods, supports growth in net sales by attracting new customers and encouraging repeat visits from existing customers. Grocery Outlet's value proposition and personalized customer experience have resonated particularly well with middle- to higher-income consumers, who have demonstrated increased spending and satisfaction with the company's product selection and value.

Opportunistic Sourcing and Supplier Partnerships

Grocery Outlet's flexible buying model and strong relationships with suppliers allow the company to capitalize on a wide range of opportunistic purchasing opportunities. The company's growing scale and reputation as a reliable partner have enabled it to secure access to a greater variety and volume of discounted, name-brand products across a wider geographic area.

The recent closure of $0.99 Only Stores, a notable participant in the secondary sourcing market, has presented additional opportunities for Grocery Outlet. The company has already started to see more product come its way that was previously directed to $0.99 Only, and it expects this trend to continue. Grocery Outlet is also exploring potential real estate opportunities that may arise from the $0.99 Only liquidation process.

In addition, Grocery Outlet recently held its annual supplier conference, where it engaged in strategic conversations to identify new opportunities and strengthen partnerships with both longstanding and newer suppliers. The company added over 600 new supplier relationships in 2023 and expects to add a similar number in 2024, further enhancing its access to a diverse and constantly changing selection of opportunistic products.

Risks and Challenges

Grocery Outlet's first quarter of fiscal 2024 results were impacted by operational and financial challenges stemming from the implementation of new technology platforms in late 2023. These system upgrades resulted in disruptions to the company's business operations, including ordering and inventory issues, as well as payment processing challenges.

The company estimates that these system-related issues negatively impacted first quarter gross margin by approximately 210 basis points, with 110 basis points of the impact being higher than originally expected. The disruptions led to reduced data visibility and more difficulty managing margins, both for Grocery Outlet and its IOs.

To support its IOs during this transition, Grocery Outlet elected to provide $12.4 million in commission support in the first quarter. The company also incurred additional expenses related to catch-up invoice processing and margin reconciliation at the end of the quarter, further impacting profitability.

Grocery Outlet expects the financial impact of these system-related challenges to be largely contained to the second quarter of fiscal 2024. The company has made progress in resolving known issues, including fixing store-level reporting, which has allowed it to end the commission support program. However, some residual costs related to margin and commission calculations from the physical inventory counts are expected to continue into the second quarter.

Looking ahead, Grocery Outlet is focused on optimizing the new systems for improved functionality and process efficiencies, as well as enhancing data visibility to better manage the business. The company has brought on additional resources, including a new Chief Operating Officer, to accelerate progress and reduce reliance on third-party consultants.

Outlook

Despite the short-term operational and financial challenges, Grocery Outlet remains confident in the long-term growth potential of its business. The company continues to execute on its strategic growth initiatives, including new store openings, the integration of the United Grocery Outlet acquisition, and the introduction of a private label program.

In the first quarter of fiscal 2024, Grocery Outlet opened six new stores, increasing its total store count to 474. The company now expects to add 58 to 62 net new stores in fiscal 2024, including the 40 United Grocery Outlet stores acquired in April 2024. This represents a significant acceleration in Grocery Outlet's store growth compared to the prior year.

The integration of the United Grocery Outlet acquisition is progressing well, and Grocery Outlet is focused on expanding the assortment, investing in store refreshes and new fixtures, and introducing its marketing programs to the Southeast region. The company also plans to leverage United Grocery Outlet's multi-temperature distribution center to access more opportunistic product that can benefit both Grocery Outlet and United Grocery Outlet stores.

In the third quarter of fiscal 2024, Grocery Outlet will introduce its private label program, which the company believes will become a key differentiator and provide even more value and excitement for its customers. The initial private label offerings will be in the beverage and grocery categories, with plans to expand into additional categories over time.

For the full fiscal year 2024, Grocery Outlet now expects comparable store sales growth in the range of 3.5% to 4.5%, up from the previous guidance of 3% to 4%. The company also expects to achieve adjusted EBITDA of $252 million to $260 million and adjusted earnings per share of $0.89 to $0.95 per diluted share.

Conclusion

Grocery Outlet Holding Corp. is a unique specialty discount retailer with a differentiated business model and a strong value proposition that continues to resonate with customers. Despite the short-term operational and financial challenges related to its technology platform upgrades, the company remains well-positioned for long-term growth, driven by its flexible buying capabilities, strategic initiatives, and the resilience of its entrepreneurial IO network.

As Grocery Outlet works to resolve the remaining system integration issues and revert to more normalized margins and profitability, the company's underlying business fundamentals remain healthy. With a focus on enhancing data visibility, improving process efficiencies, and executing on its growth strategies, Grocery Outlet is poised to capitalize on the significant white space opportunity in the U.S. discount grocery market and deliver value to its customers and shareholders.