Why Natural Grocers Should Be on Your Watchlist

Why Natural Grocers Should Be on Your Watchlist

Sales of organic products in the U.S. increased at an average annual rate of 17.86% -- between 1990 and 2011 -- to nearly $32 billion. Organics are only a portion of the health-conscious movement in the U.S., but signify increased interest from the public in healthier products. Long-term investors looking to capitalize on these trends should add Natural Grocers by Vitamin Cottage to their watchlist.

Investors have seen several health food chain IPOs since 2010. This August, Sprouts Farmers Market joined The Fresh Market and Natural Grocers by Vitamin Cottage on the public stage with Whole Foods Market . Among a competitive field, Natural Grocers stands out as a unique concept that is enjoying impressive growth.

A principled family business
In 1955, Natural Grocers by Vitamin Cottage was founded by Margaret and Philip Isely in Colorado. Margaret and Philip believed that the more health and nutrition information was made available to people, the healthier people would want to eat and live. Natural Grocers by Vitamin Cottage was founded upon five core principles that the company follows to this day:

1. Nutrition Education. "Empowering our customers and our employees to take charge of their lives and their health is the foundation upon which our business is built."

2. Quality. "Providing the highest quality groceries and supplements; Natural Grocers branded products; and only USDA certified organic fresh produce at the best prices in the industry is part of our mission."

3. Every Day Low Pricing. "We work hard to secure the best possible pricing on all of your favorite natural foods and supplements."

4.Community. "From free nutrition education lectures, to bag-free checkouts, to sourcing local products... we work hard to make sure that we are serving the communities that help shape our world."

5. Employees. "Supporting [employees] with free nutrition education programs, good pay and excellent benefits is what helps us to ensure happy, healthy employees who deliver world-class customer service to our customers."

Nearly 60 years after its founding, Natural Grocers serves as a specialty retailer -- only offering organic and natural products -- including produce, meat, vitamins and supplements, body care, and pet care products.

Natural Grocers by Vitamin Cottage is still in the hands of the Isely family. Half of the company's board of directors is made up of the Iselys, all of whom have served in their executive positions since 1998, and spent many years prior working in lower-level positions within the company. Kemper Isely, Chairman and Co-President, joined the company as an employee at the age of 14 in 1977.

Committed management and superb financial growth
The four Iselys on the board own a combined 37.6% of Natural Grocers. Given that Natural Grocers remains a principled family business -- most of the Iselys have already spent well more than 20 years with the company -- I have confidence that this family and managerial team is focused on the long-term success of the business.

Perhaps most importantly, the financial results confirm the validity of the Natural Grocers concept. In 2013, Natural Grocers' total sales increased 28% to $430.7 million, same-store-sales increased 11.1%, and adjusted net income increased 35% to $10.9 million. This is a concept that seems to be firing on all cylinders.

Extensive room for future expansion
Currently, Natural Grocers operates 72 stores in 13 states. The company has increased its store count by an average annual rate of 21.2% over the past three fiscal years. The average Natural Grocers store comes in at 12,300 square feet, roughly a third the size of a typical Whole Foods store.

In the company's 2012 IPO prospectus, management outlined its belief that the U.S. market can support 1,100 Natural Grocers stores. This represents more than a 15-fold increase from current store levels. Not too shabby, if anything close to that level of expansion can be pulled off over the next two decades.

To contrast, Whole Foods currently has 367 stores in operation in the U.S., Canada, and the U.K. Whole Foods' CEO John Mackey believes the U.S. market can support 1,200 Whole Foods stores.

The Fresh Market operates 146 stores in 26 states, while Sprouts Farmers Market operates 167 stores in 8 states. Natural Grocers has the smallest stores, on a square footage basis, compared to these competitors.

Natural Grocers is yet to set foot in California, Washington, or Pennsylvania, the top three states in terms of organic sales. The company's financial success thus far has been the result of careful expansion out of Natural Grocers' home turf in Colorado.

Foolish bottom line
Shares of Natural Grocers have more than doubled in 2013, with the stock currently sitting at a P/E just below 90. While the company's high rates of financial growth and store expansion may justify the stock's premium, the business is not without its financial flaws. The company has struggled to produce positive free cash flow over the past several years, pressuring future expansion to be financed through debt, until cash flow production measurably improves.

Because of its experienced, principled, and committed ownership, combined with an increasingly popular concept for health-conscious customers, Natural Grocers by Vitamin Cottage is well worth adding to a watchlist for further study and as a potential future investment.

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The article Why Natural Grocers Should Be on Your Watchlist originally appeared on Fool.com.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Fool contributor David Kretzmann owns shares of Whole Foods Market. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_Kretzmann. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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