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The Science of Hitting
The Science of Hitting
Articles (622) 

Ollie's: A Tough Close to 2019

A look at the retailer's recent financial results

March 23, 2020 | About:

Ollie's Bargain Outlet Holdings Inc. (NASDAQ:OLLI), which operates a chain of discount retail stores primarily in the eastern half of the United States, recently reported results for the fourth quarter of fiscal 2019. For the quarter, revenues increased 7% to $422 million, with a double digit increase in the unit count more than offsetting a 5% decline in comparable store sales (note that this is lapping a two-year stack of 10% gains). The weakness in comps in the fourth quarter was due to a shorter holiday shopping season (six fewer days between Thanksgiving and Christmas), as well as a bet on the toys category that did not pay off. As CEO John Swygert noted on the conference call, “this proved to be a more challenging sales period than we anticipated.”

For the year, Ollie's revenues increased 13% to $1.41 billion, with a 14% increase in units offset by a 2% decline in comps (lapping an increase of 4% in 2018, with the two-year stack in-line with management's long-term expectations). As shown below, Ollie’s store count has nearly doubled over the past five years, to 345 units at year end 2019.

Gross profits in 2019 increased 12% to $556 million, with gross margins down 60 basis points to 39.5% on higher supply chain costs. Adjusted operating income increased 5% to $171 million, with operating margins down 100 basis points to 12.1% on lower gross margins, as well as deleveraged operating expenses on lower sales per store. Adjusted net income increased at a comparable pace to operating income, up mid-single digits to $129 million. The same is true for diluted earnings per share, which increased 7% year over year to $2 per share.

For the year, Ollie’s generated $105 million in cash from operations, which was down from 2018 due to net working capital investments. They spent $34 million on investing activities, with $77 million for new stores and a third distribution center offset by $42 million in proceeds from a sale-leaseback transaction involving three former Toys "R" Us stores.

In 2019, the company spent $40 million to buy 689,000 shares of stock at an average cost of $58 per share. The entirety of those repurchases occurred in the third quarter; as of today, $60 million remains under the company's repurchase authorization.

Ollie’s will face some short-term pressure as a result of the novel coronavirus (Covid-19). As management noted on the call, only 20% to 25% of their business falls into the “essentials” category, which includes consumable products in food, cleaning supplies and personal hygiene. For their average customer, we may be entering an economic environment where extra spending money will be hard to come by. As a result, Ollie’s is looking to refocus its merchandising efforts.

While the near term may present some challenges for the retailer, I think the company’s balance sheet will provide ample support during this period. They currently have more than $100 million in cash and no debt, along with $100 million available on their credit line.

Conclusion

What makes Ollie’s interesting for potential investors is management’s belief that they can still triple the store count. That growth comes with very attractive unit economics. The investment to open a new Ollie’s is roughly $1 million, including inventory, fixtures and other equipment, on which the company generates, on average, half a million dollars in operating income per year. In my mind, that suggests each $1 million invested in the business is likely to result in $5 million or more of market value. That’s a nice return on investment if you can get it. Given those numbers, it’s not difficult to see why investors have historically paid up for Ollie’s growth prospects.

However, that has started to change. The passing of co-founder Mark Butler in December 2019 introduced "key man risk." Throw in recent equity weakness and Ollie’s is suddenly trading at $39 per share, down more than 50% from a year ago. At today’s price, the company is valued at roughly 20 times trailing earnings.

After a tough quarter, the questions remain: is this company ready to operate without Butler? Will there be a smooth transition from his 15-plus years of leadership to a new CEO? I do wonder if the management team he built around him is truly ready to take the lead. We’re going to find out soon enough: the impact of the coronavirus will be an early test for the new CEO.

Looking ahead to 2020, there may be reason for caution. As management noted on the earnings call, they’ve faced significant headwinds in recent days, with comps down 10% to 20%. While a quarter of Ollie’s sales are in the “essentials” category, that leaves the other three-quarters of the business out to dry. In my mind, this could be a year of sizable comp store sales declines, lower margins and slowing unit growth. Through that lens, Ollie’s has a forward price-earnings multiple that could be around 30 times.

Considering what Mr. Market is offering right now, that does not strike me as the best opportunity. Using a 15% discount rate, my model returns a fair value estimate of roughly $30 per share. For those reasons, I’m firmly on the sidelines for now.

Disclosure: None

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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