Grocery Outlet Holding Corp. GO is currently trading at a forward 12-month price-to-earnings (P/E) ratio of 15.29, which is notably lower than the industry’s average of 18.69 and the S&P 500’s ratio of 22.22. At a first glance, this discount may suggest that GO is undervalued, potentially offering investors a chance to buy at a bargain. A lower P/E ratio often signals that a stock may be priced attractively relative to its earnings potential, which can be appealing to value-focused investors.

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However, GO’s stock has underperformed significantly over the past six months, with a steep decline of 38.8%. This sharp drop stands in contrast to the broader industry, which grew by 6.8%, and the gains of the Zacks Consumer Staples sector and the S&P 500, which rose by 4.7% and 15.2%, respectively. Such underperformance raises concerns about whether GO’s lower P/E ratio is truly a value play or if it reflects fundamental issues that have yet to be fully addressed.

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So, it’s crucial to look beyond the numbers and assess whether this discount truly represents a buying opportunity or if it reflects underlying risks in the company’s growth trajectory. Currently, GO is also trading below its 50-day and 200-day moving averages, which signals potential weakness and a lack of positive momentum.

Let’s Dig Into Grocery Outlet Stock

Grocery Outlet has faced significant challenges related to its systems transition, which began in September last year. This transition has disrupted operations, negatively impacting efficiency and financial performance. Management highlighted that disruptions due to the implementation of new technology platforms hurt the gross margin in the second quarter by 100 basis points.

Although improvements have been made, the ongoing challenges could hinder margin expansion and operational scalability in the near term. Grocery Outlet guided a full-year gross margin of 30.5%, down from 31.3% guided earlier. The current projection showed an 80-basis point contraction in the gross margin from the year-ago period.

Grocery Outlet is also grappling with rising selling, general and administrative (SG&A) expenses, driven by increased costs associated with independent operator commissions, store occupancy and incentive compensation. In the second quarter of 2024, SG&A expenses rose 11.4% to reach $323.1 million. This upward trend in SG&A expenses has been evident over the past few quarters and could strain profits.

We note that the Zacks Consensus Estimate for third-quarter earnings per share, which has been stable at 27 cents over the past 30 days, suggests a decline of 12.9% from the year-ago period.

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Find the latest EPS estimates and surprises on Zacks Earnings Calendar.

Grocery Outlet Building the Blocks

Despite challenges, Grocery Outlet's strategic focus on opportunistic purchasing, targeted marketing, store expansion and e-commerce initiatives is demonstrating potential. With its distinctive business model featuring opportunistic sourcing and an Independent Operator structure, GO differentiates itself from conventional retailers.

Grocery Outlet has unveiled its customer-focused private label program, GO Brands, aiming to introduce 100 new products by the end of the year. The program will feature three lines: SimplyGO, GO Home & Haven and GO Paw & Pamper, showing the company’s commitment to providing valuable products for its customers.

Investment Guidance on GO Stock

While Grocery Outlet’s lower P/E ratio may appear as a value opportunity, its significant stock decline, operational challenges and margin contraction raise concerns about whether this discount truly reflects potential upside or ongoing risks. The company’s system transition and rising expenses have strained profitability. However, strategic initiatives like opportunistic sourcing, store expansion and the introduction of its private label program signal efforts to reinvigorate growth. Investors should weigh these initiatives against the near-term operational hurdles.

GO currently carries a Zacks Rank #4 (Sell).

Three Stocks to Consider

Here, we have highlighted three better-ranked food stocks, namely, The Chef's Warehouse CHEF, Flowers Foods FLO and Ollie's Bargain Outlet OLLI.

The Chef’s Warehouse, which engages in the distribution of specialty food products, currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

CHEF has a trailing four-quarter earnings surprise of 33.7%, on average. The Zacks Consensus Estimated figure for The Chef’s Warehouse’s current fiscal year sales and earnings indicates growth of 9.7% and 12.6%, respectively, from the year-ago reported numbers.

Flowers Foods, one of the largest producers of packaged bakery foods in the United States, currently carries a Zacks Rank #2 (Buy). FLO has a trailing four-quarter earnings surprise of 1.9%, on average.

The Zacks Consensus Estimate for Flowers Foods’ current financial-year sales and earnings calls for growth of around 1% and 5%, respectively, from the year-ago reported numbers.

Ollie's Bargain, the extreme-value retailer of brand-name merchandise, currently carries a Zacks Rank #2. OLLI has a trailing four-quarter earnings surprise of 7.9%, on average. 

The Zacks Consensus Estimated figure for Ollie's Bargain’s current financial year sales and earnings indicates a rise of around 8.8% and 12.7%, respectively, from the year-earlier levels.

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