Ollie's: A Discount Retailer at a Reasonable Price
Ollie's Bargain Outlet (NASDAQ:OLLI) operates a chain of more than 300 discount retail stores throughout the eastern half of the United States. The value proposition to customers is an assortment of branded merchandise in a treasure hunt shopping experience at dramatically reduced prices. Based on management's assessment, their products are sold at up to 70% below department stores - what they call "fancy stores" - and up to 20% to 50% below prices at mass market retailers. To put it succinctly, they sell "good stuff cheap".
Ollie's is able to offer these significantly discounted prices to customers because they acquire an assortment of constantly changing closeout merchandise from hundreds of retailers and manufacturers who either want to or need to liquidate inventory. This means a family can find a toy from one of the earlier Toy Story movies for their child at Christmas for $10 when the current Toy Story 4 model might sell for $15 or $20 at Walmart (NYSE:WMT).
Even as the retail world moves online, there's reason to believe that Ollie's relationship with its manufactures will remain. As noted in a recent Forbes profile on the company, "A lot of vendors would prefer that [their closeout merchandise] is not advertised all over the internet."
As shown below, the store base has grown at a mid-teens compounded annual growth rate in recent years.
As a result, annual revenues have followed a comparable path higher.
The unit economics show the attraction of continued store growth. The investment to open a new Ollie's is roughly $1 million (including inventory, fixtures and other equipment). On that outlay, a store will generate roughly $4 million in annual revenues and roughly $500,000 in operating income. Across the base, Ollie's generates more than $400,000 per box in cash flow from operations. As that math suggests, the payback period on a new unit is roughly two years, so it's not hard to see why investors cheer as the company continues to grow the unit count at an impressive clip.
In addition, management believes that there's room to run. Based on their research, they believe the U.S. can support somewhere around 1,000 Ollie's - or nearly three times as many as they have today.
Since 2003, Ollie's has been run by co-founder Mark Butler. That changed last week when he passed away. The concern of many investors is that there's "key man" risk here. I'd argue that some of Butler's own words support that conclusion. Here is an excerpt from Butler at the 2019 ICR Conference:
"This is the secret sauce. It's relationships. It's our buying team. We have an incredibly highly experienced and disciplined merchant team. My three key merchants have been with me a combined 64 years... that's what it's all about - it's developing the relationships, and these are the key buyers. I can tell you that below these, we have what we call the minor leagues, and those minor leaguers, all of a sudden, they've been with us five, six years. Now they're tenured veterans and they're becoming dangerous. So, we're building the merchant team, the buying team."
How many of these supplier relationships were Ollie's, as opposed to Butler's? Will there be a smooth transition from his 15-plus years of leadership to a new CEO? While I take some comfort from the fact that the relationship between Ollie's and suppliers is clearly beneficial to both parties (they have been working with their top 15 suppliers for an average of 13 years), I do think it would be imprudent to assume no risk of a short-term hiccup, especially when you need the sharp buying required to support best in class gross and operating margins.
For what it's worth, I've heard scuttlebutt from a fellow investor that suggests Butler still approved somewhat immaterial purchases until his death. I do wonder if his second in command is truly ready to take the lead. Of course, if you're a long-term investor like myself, you could argue a temporary blip as incoming CEO John Swygert gets his feet under him may ultimately prove to be an opportunity as opposed to a material long-term risk to the business (note that Swygert has worked with Butler at Ollie's since the early 2000's).
Conclusion
For those who follow my work, you know that I think highly of Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR). They are among a short list of retailers that I believe will be able to withstand the pressures brought by the continued growth of e-commerce, enabling them to keep generating attractive returns on invested capital. After the work I've completed on Ollie's, I believe they belong in that bucket as well. Like those names, I also think that many of the people analyzing the business may underappreciate the value offered to their core customers because it's not the world they live in. The average money manager does not spend his or her time shopping at Ollie's and does not truly appreciate what it might mean to save $10 when buying a Christmas present for your kids.
In terms of the valuation, Ollie's is likely to earn nearly $2 per share this year. At $60, the stock trades around 30 times earnings. While that probably sounds high, I think it properly reflects the fact that each $1 million that the company invests to build a new store is likely to create somewhere between $5 million and $10 million in value for shareholders. If you believe that the company has a long runway for continued unit growth ahead, you can see how paying a higher than average multiple on current earnings will still work out well for long-term investors.
Personally, I'm not ready to make an investment quite yet. I need more time to look at some of their peers, particularly those that have ultimately failed while operating a similar business model. However, if that exercise doesn't cause much concern, it's likely that I'll invest in Ollie's.
Disclosure: None
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