Hi there. It has been a few weeks.
Today, for the first time I want to provide a more detailed analysis of a stock that I am following and which I think offers an good investment opportunity given both its exception past performance and fundamentals.
Meet Ollie´s Bargain Outlet
The company I will elaborate on is Ollie´s Bargain Outlet, an American extreme value retailer which had its Initial Public Offering in July 2015. Its business model is to sell brand and no name products at drastically reduced prices through in 234 stores across the United States. 70% of the products offered are brand products and the remaining 30% are private label products. Merchandise is priced 70% below department store levels and 20%-25% below the prices of market retailers.
The original premise of Ollie´s Bargain Outlet when it was founded in 1982 was that “everyone loves a bargain”. This still holds true nowadays. Under the motto “Good Stuff Cheap” Ollie´s Bargain Outlet targets a wide varieties of customers from all demographic and social classes. In fact, the business model allows continuous profits in both strong and weak economic cycles. It not only offers products at reduced prices but a special shopping experience too. Through continuously varying merchandise and product offerings the stores offer a “treasure hunt” shopping experience and the slogan “When it´s gone it´s gone” induces a sense of urgency to buy NOW before the good stuff is sold out.
The variety of products is large, feeding into the treasury hunt experience. As one can see below, from food to books to electronics one can find something in every product category.
Source: Ollie´s Bargain Outlets Annual Report 2016
Despite its low-price profile, the company mostly profits from a loyal costumer base. Through its “Ollie´s Army Customer Loyalty Program” as of early February 2017 it reaches 7.3 million clients, an increase of 31.2% compared to the previous fiscal year. This is especially striking and advantageous since members of the loyalty program tend to spend approximately 40% more than an average customer.
As will become even more clear later on in the analysis, the company has been able to grow strongly in past years. Continuously more stores have been opened and net sales have increased both based on a comparable store and a non-comparable store basis. Comparable store sales increased to $ 736 million in fiscal year 2016, an increase of 3.2% compared to the previous year. This statistic is important because it highlights the fact that sales not only increased because of new store openings. Instead, existing stores are able to sell larger volume too. Non-comparable store sales increased from $ 49 million in fiscal year 2015 to $ 154.3 million one year later. Below, growth figures for both store openings and sales growth are represented.
Source: Ollie´s Bargain Outlets Annual Report 2016
Ollie´s growth strategy consists in the expansion of the store base across the united states, the increase of product offerings and leveraging the Ollie´s Army loyalty program. Below, one can see that currently the company is only operating in the east of the United States. According to a research report however, there is demand and capacity for 950 Ollie´s stores throughout the country. Given the fact that there are only 234 stores as of this writing, there seems to be ample opportunity to grow towards the west. This fact is important because Ollie´s efficiency in operating its stores is impressive. The average store has a size of 25000 to 32000 square feet and there is ample supply of real estate at low prices fitting the store requirements. Generally, the opening of a new store requires and initial investment of $ 1 million and the average payback period amounts to 2 years. Within the first 12 months of operations, the average store produces sales in excess of $ 4 million.
Source: Ollie´s Bargain Outlets Annual Report 2016
Ollie´s Stellar Financial Performance
We already have seen that sales have trended strongly in the last years both due to increased sales in existing stores and new store openings. At the same time, other important financial measures such as Earnings Before Interest Taxes Depreciation and Amortization, Net Income and Earnings per share have demonstrated impressive movements too.
While increases in revenues are a good sign, what finally matters are earnings. And as well in this category the prospects are strong. Income has been increasing a lot and especially Earnings per share have seen a stellar growth. What is even more appealing is the fact that EPS growth has been accelerating too. What makes stock prices move at last are earnings and especially the earnings per share growth is an important indicator for the stock´s future direction.
Strong growth is a good indicator but strong growth while beating analysts´ expectations at the same time is even better since expectations will be adjusted upwards and additional attention will be created for the stock. As we can see below, quarterly earnings per share have been continuously rising in the last fiscal year. At the same time, analysts expectations were beaten in every quarter.
An increase in earnings may very well just be the result of higher sales. However, the overall profitability for the company has experienced a strong improvement as well as can be seen below. Additionally, these margins generally are above industry average and median.
Another factor that is important to be considered is a retailer´s efficiency in selling its inventory. For this purpose the “days inventory” measure is calculated. One can observe, that the days inventory have been decreasing between 2015 and 2016 which indicates that less time is needed to sell the merchandise. Additionally, the days receivable measure shows how long it takes to collect receivables. Even though this measure has increased in the last year, the days receivables are less than one day which seems to be of no concern at all.
So, after all these digressions on how awesome the company is let us consider whether the stock is actually a buy. Ollie´s Bargain Outlet currently has a market capitalization of $ 2.04 billion and the stock trades under the ticker Olli at $ 33.6. To get a first impression of relative over-valuation or undervaluation it is a good idea to compare the company to its peers. For this purpose various “similar” companies from the same industry are chosen and their EV/EBITDA, margins and EPS growth during the last five years are displayed below. The EV/EBITDA measure may be taken as an indicator of relative over-or undervaluation. It shows at what multiple of EBITDA the entire enterprise, both debt and equity, is trading. Looking at this measure we see that Ollie´s multiple is double both the industry average and the median. Based on this measure the company seems grossly overvalued.
But is this all to look at? As we have seen previously Ollie´s Bargain Outlet has performed exceptionally well in the past both in terms of earnings growth and efficiency improvements. If we compare Ollie´s margins and EPS growth to the ones of its peers it becomes apparent that it outperforms the peer group in every category. Only the EPS growh over the past five years is less than the peer group´s average one due to one outlier having an annualized growth rate in excess of 300%. As we see from the median however, Ollie´s growth is exceptional in this category too.
Given these completely different characteristics, it seems difficult to evaluate whether the high EV/EBITDA margin implies over-valuation or whether the strong past performance and profitability even implies undervaluation.
In order to obtain a better understanding of the intrinsic value of the company, therefore an intrinsic valuation is built.
For this purpose I apply a 6-stage growth model. After two years, earning growth is expected to gradually decrease from the current average level of the past years (26%) to the stable growth rate of 2%. The value of the company is then calculated as follows.
In order to discount the cash flows, the cost of equity is calculated via the CAPM model. As risk-free rate the 12 months US government bond yield of 1.06% is chosen. The company´s beta is constructed with a bottom up approach. Given the unlevered industry betas of various retail sectors Ollie´s unlevered beta is computed by weightings according to the its shares of the product categories. Then, the unlevered beta is relevered with a Debt/Equity ratio of 30% and a tax rate of 37.9%.
Given the unlevered beta of 0.823, a D/E ratio of 30% and a tax rate of 37.9% the levered beta can be calculated as follows.
|βl = 0.823(1+(1-0.379)*0.3) = 1.023
The current implied equity risk premium for the United States is 5.69 %. Thus, the cost of capital for the high growth period is
ke = 1.06% + 1.023* 5.69% = 6.88%
Assuming a long-run beta equal the on of the economy, in the stable growth period the cost of equity reduces to 6.75%. (1.06% +1*5.69%)
Given all these factors the discounted cash flows can be calculated and a value per share of $ 44.94 is obtained. Trading at $ 33.6 the stock would trade at a strong discount to intrinsic value.
There are various risks for Ollie´s business model and the accuracy of my analysis.
- The discounted cash-flow analysis is based on various assumption. It is especially sensitive to changes in growth rates. I have assumed further strong growth in EPS for the next years. Even slightly adjusting these estimates downwards can strongly affect the intrinsic value of the stock.
- The simplified usage of earnings per share employed in my calculation instead of dividends or free cash flow to equity may considerably influence the obtained result.
- Operating leases have not been transformed into debt in my calculation, possibly influencing the outcome.
- The business model of Ollie´s Bargain Outlet is reliant on the continuous availability of cheap merchandise. The company purchases overstock, discontinued merchandise, cancelled orders, excess inventory and buybacks from retailers. It has over 1000 suppliers and no one supplier has a larger share than 6%. Nevertheless, the company is reliant on the supply of cheap products. The lack of these would pose a severe challenge for the business.
- The company always faces the risk of not correctly anticipating customers´ product demands.
- Increased competition from other retailers.
- Due to cost awareness, Ollie´s Bargain Outlet does not possess online retailing capabilities. It may be possible that online retailers will take away market share from the company.
- There exists the risk that the customer loyalty program may fail to retain customers in the future.
Keeping all this in mind, I am very enthusiastic about the prospects of this company. While I have no position in the stock so far, I might enter soon.
Until next week.
Please keep in mind that I am not a professional investment advisor. The previous article is for entertainment and educational purposes only. The content is no investment advice and should not be regarded as such under any circumstances.