Grocery Outlet reported Q2 EPS of $.42 vs. consensus expectations of $.23. The upside was driven by better sales and margins. Revenue grew 24.5%, driven by a SSS increase of 16.7% vs. consensus expectations of 13.8%. Traffic was down for Grocery Outlet like it has been for other grocers during the pandemic. It’s also understandable given the growth in e-commerce orders elsewhere and a certain segment of shoppers being wary of in-store shopping. Traffic has remained steady in Q2 and Q3, while the size of the basket has decelerated.
Gross margins expanded 80bps due to reduced markdowns and shrink from faster inventory turnover, offsetting some COVID-19 cost pressure. Commodity inflation did not impact Q2, but management expects it to be a headwind in the second half of the year. SG&A grew 25.6%, less than gross profit growth of 27.7%, driven by variable commissions (directly tied to gross profits) and COVID-19 cost pressure. Adjusted EBITDA grew 34.7%. Inventory grew 13.1%. Management said SSS trends in Q3 to date are up 10%, but expects it to slow further as the quarter progresses. Management now expects to open 30-32 stores, up by two and capex of $95-105M, up by $5M. The real estate market is very welcoming of a growing grocery chain.
With unemployment still in the double digits and supplemental unemployment checks missing and possibly shrinking, the consumer environment is still favorable for Grocery Outlet. There is a larger portion of the population that is looking to spend less on food needs. Grocery Outlet is still finding the buying environment for food as more favorable. The company continues to develop new supply relationships with non-traditional suppliers, including food service, hospitality, fitness centers, cruises, and hotels. Management said increasing private label items is an opportunity they are not focusing on at the moment. Grocery Outlet primarily uses the private label to fill in holes in the everyday item assortment, as seen in the following illustration. Branded goods at reduced prices sell best, and the fact that the company is not looking to increase the private label assortment speaks to the favorable buying environment and future sales prospects.
One unanticipated headwind from the pandemic is that more traditional grocery store managers are not looking for a change in employers, so Grocery Outlet is expanding its recruitment outside the grocery business. Our 2020 EPS estimate was significantly higher than consensus, and we are raising it further for the Q2 beat. EPS power of $1.25 is beatable as well.
