Ollie's Bargain Holdings: Uncovering the Secrets of this Discount Retailer
Summary
Ollie's Bargain Outlet Holdings has more than quadrupled its store count since 2010. The company is closing in on its 500th store opening.
Ollie's Bargain Outlet Holdings has achieved +40 consecutive profitable quarters and counting.
A strong balance sheet with essentially no debt and the ability to fund its own growth is an opportunity few companies enjoy.
During the previous quarters, weaker fundamentals have hindered growth, however, investors could see a comeback to a more profitable path.
Ollie's Business Overview
Ollie's Bargain Outlet Holdings (“Ollie”) is a chain of discount retail stores with 468 locations (as of Jan-23) across 29 states in the United States. With the motto “Good stuff cheap” OLLI offers its customers a treasure hunt feeling by offering products up to 70% below department and specialty stores.
This deal-driven philosophy creates a sense of urgency which leads to customers wanting to take advantage of opportunities that may not be there in the near future and spending more than anticipated. The business model has proven successful for 40 years, with growth since its foundation in 1982. In 2010 the company achieved its 100th store opening, this number would be doubled 5 years later and more than quadrupled by 2022 when it opened its 450th store. The driver of this growth comes from the economics of Ollie’s stores, with a $1m ($250k capital expenditures) initial investment the company is able to recoup its money in ~2 years. This enables the company to turn a profit and expand with new stores with its own capital.
Profitability Machine
Let’s start with the basics. Ollie’s balance sheet is the forte of its castle. With essentially no debt, the company’s current assets ($754 million) comfortably cover total liabilities ($682 million) as Financial Year End (“FYE”) 2023. Additionally, the company enjoys a strong liquidity position with $271 million in cash and equivalents (management targets a cash position of ~$200m), which gives the company flexibility and enough firepower to fund growth, repurchase shares, etc.
Such a strong balance sheet is propelled by the profitability machine Ollie is. Since the company went public, Ollie has turned a profit every year. This profit is driven by its opportunistic buying from retailers and manufacturers which consequently leaves the company with a 40% gross margin (which is what management consistently aims to hit every quarter). This opportunistic buying comes about by taking advantage of imbalances in retailers’ demand and manufacturers’ supply. In case of a surplus, manufacturers need to make up for the costs associated with the goods, as such they sell at a deep discount. Ollie is able to find opportunities in these pockets.
Going back to the financials, Ollie has a relatively low SG&A (approx. ~27% of total sales) which is optimized by growth, hence as the company grows the percentage should shrink. Further to this, OLLI has low depreciation and amortization and no interest payments which have led the company to achieve profitable results for more than 40 quarters consecutively. The beauty of Ollie’s financials is the high free cash flow conversion it has historically been able to achieve. As maintenance capital expenditures account for less than 3% of revenues, the company is able to transfer most of its profits into its balance sheet. Please see below the historical performance of Ollie since it went public.
Short FYE 2023 Recap
Ollie had a tough year during FYE 2023, nonetheless, it was able to produce profitable results and it managed to generate a modest free cash flow (“FCF”) of $63 million. During the year Ollie saw its margins deteriorate along with bigger-than-usual inventory cash outflows, which did not compare well to the significant and positive growth achieved two years back in 2020. If the company’s management can steer Ollie back to a 40% gross margin and above 10% net profit margin, the company could start generating higher free cash flows. The picture would then change as Ollie would enjoy excess cash (similar to what happened during 2020) which it would have to deploy through share buybacks, dividends, or funding accelerated growth.
Ollie: a Recession-Proof Company
Ollie strives during recessions or difficult economic environments. As a former chief financial officer, Jay Stasz said during an investor call: "We feel like recession resistant. In 2008, we had about a flat comp. We did see people kind of trading down to maybe try Ollie's. And then what we realized in 2009 is that those people stuck around, and we had a strong comp. Our comp was about 7.9% positive in 2009.”. More recently, during the pandemic, consumers turned to OLLI driving same stores sales up by 53% and 15% in the second and third quarters, respectively. Ollie finished the pandemic year with record financials, delivering an increase in revenues of 28% to $1.8 billion, a profit margin of 13.4%, and a free cash flow of $331 million.
During FYE 2023, Ollie had a tough time hitting its gross margin target, which management consistently aims at 40%. This in turn impacted the rest of the income statement, with Ollie finishing the year with a 5.6% net profit margin.
The company also had a tough time dealing with supply chain disruptions higher inventory levels, and higher costs during FYE 2022 and 2023. During FYE 2022 Ollie's cash flow was significantly impacted by changes in inventory with cash outflows due to inventories at $114 million. For reference, the usual levels are around the $20 million to $40 million mark. This heavily impacted Ollie’s cash flow from operations during the year.
It is important to note that the company significantly improved its cash flow from operations by 155% compared to the previous year. This in turn also helped improve the free cash flow generated by the company from $10 million during FYE 2022 to $63 million in FYE 2023. Furthermore, the company improved its free cash flow conversion to 55%.
The company used a portion of its free cash flow for the year in order to repurchase shares. For reference, management has repurchased stock to the tune of $265 million during the previous 3 years.
What drives profitability? OLLI’s Army may be OLLI’s hidden MOAT
Ollie's is not a membership store, nonetheless, it offers customers the opportunity to join Ollie's Army in order to receive extra perks like discounts, events, etc. The Ollie's Army has been a great success, evidenced by its significant growth since 2006 when it had around 500 thousand members, this number has ballooned to a whopping 13.2 million members as of Jan-23 (not bad for a discount retail store). Why is this number important? Well, Ollie's Army members spend approx. ~40% more in each store visit than non-Ollie's army members.
It is also important to note here the incremental percentage of sales the Ollie's Army has come to account for, in 2014 Ollie's Army accounted for 55% of total revenues, this number increased to 70% by 2017 and north of 80% by January 2023. We can derive from these numbers that Ollie's Army members are fervent loyalists of the company. Now, in order to be an Ollie's Army member, the person must have bought in the store in the last 24 months, from this the company records a ~95% retention ratio.
But why are these members so loyal? Well as mentioned earlier Ollie's offers a steep discount (up to 70%) on many of its products. An analyst at KeyBanc, put these claims to a test, comparing the prices of 32 items from Ollie's with prices on Amazon. He found that one, The Beloved Christmas Quilt, a paperback, was more than 70% less. Eight were 60% to 67% off, and Ollie's on average was 42% cheaper. Talk about cheap!
But how can Ollie's keep increasing its MOAT? Well, Ollie's MOAT is a combination of its ability to grow which enables the company to take advantage of bigger and better deals, and the ability of the company to offer these buying opportunities to its Ollie's army loyalists. Given manufacturers and retailers need to unload excess inventory in a single deal, Ollie's growth and ability to pick more and better deals will enable it to present a better offering to customers.
Ollie’s Runway Ahead
Even though Ollie's has experienced significant growth in the last 13 years (going from 100 stores in 2010 to +450 stores in 2022), the company still has a long runway for growth. Ollie's has a presence in 29 states yet, it has 10 or fewer stores in 13 states. It opened its third distribution center located in Texas just two years ago in 2020 and is still growing at a moderate pace with ~45 store openings per year.
Management has presented a study that suggests Ollie's could open 1,050 stores across the U.S., which gives the company the room to increase its store count by more than 200%. This does seem achievable as the company has increased store openings year after year, for example in 2015 the company opened 27 stores, fast forward 5 years to 2021 and the number grew to ~45 store openings per year.
Management has mentioned the company will keep growing at a moderate rate, yet just by historical numbers, store openings per year should keep increasing as the company gets bigger. It is important to highlight Ollie's cash balances as of FYE 2023, with $271 million in cash the company has no problem funding its own growth.
Competitive Landscape
The discount retail industry is comprised of big and small players with somewhat different business models. The big players include Target, Dollar Tree, and Dollar General. These are massive companies one can find everywhere in the United States. Although these are industry peers, Ollie's is not really a relevant competitor to them just because of the size difference. On the other hand, you have Big Lots and Five Below which are small retailers, these are the true competitors with Ollie's.
Ollie’s Business Risks
E-commerce is a threat to all retailers, Ollie's has not entered the e-commerce realm as management believes it is almost impossible to replicate what they do in online stores. However, in a fast-paced changing world, this is always a risk.
Along with many companies, Ollie's had a difficult time managing inventory levels during the past two years. It is important for management to learn from these lessons and become more efficient so that next time they are better prepared and able to keep cash flows intact.
Ollie's could turn to more aggressive financial policies like for example the issuance of debt. Should management add leverage to the company we would see a completely different picture. Nonetheless, the company has not incurred debt since it went public as such it is not expected to do so.
The Bottom Line
Ollie's is able to generate significant FCF which is expected to grow in line with its store count each year. Even though Ollie's did not perform well during the past two years, investors should look at this from the bigger picture. The company will keep increasing its store count and this will have a snowball effect which will see its free cash flow increase year after year. Management will have to deploy the cash in excess in some manner. This deployment of capital will most likely be in the form of share buybacks, dividends, or funding a more aggressive growth. The combination of steady growth in earnings per share with a more aggressive share buyback program could help Ollie's enhance its EPS or start paying attractive dividends.
However, the company currently has weaker fundamentals than in previous years, the gross margin has dipped below 40% and the profit margin is no longer above 10%. This has been caused by higher inventory levels which impact both the income statement through the cost of goods sold and the cash flow statement through changes in inventory. It is important to monitor the company on a quarter-to-quarter basis in order to see if improvements are being realized.
Disclaimer
The information provided in this article is for informational and educational purposes only and should not be construed as financial or investment advice. The content of this article is based on the authors' personal opinions and research, and it may not be appropriate for your specific investment goals, financial situation, or risk tolerance. Any investment decision you make should be based on your own research and analysis, and you should consult with a qualified financial advisor before making any investment decisions. The author of this article assumes no responsibility or liability for any investment losses or damages that may result from your reliance on the information provided herein.