Treasure Hunt In Ollie’s Bargain Outlet

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Investment Rationale

Amazon Is Not Our Enemy (Ecommerce Proof): Ollie’s Bargain goes beyond commodities when competing against the ecommerce take-over. They focus on attaining merchandise that customers won’t find anywhere else. They target that niche market of thrift buyers that are satisfied by the shopping experience of not knowing what they are going to find when they step inside a store, but whatever they find, they know it’s a deal. Large retail chains or the giants of ecommerce, like Amazon, are not a threat to Ollie’s business model as Ollie’s merchant team focuses on stocking more locally produced items or uniquely distributed ones, so they aren’t competing on price directly. Ecommerce sites may serve up personalized recommendations, but nothing beats the personal touch that real live store associates can provide and Ollie’s entire business model is centralized on their shopper’s experience through humorous signage and an approachable staff.

Treasure Hunt Experience: Based on differentiated go-to market strategy, Ollie’s is characterized by a unique, fun, and engaging treasure hunt shopping experience, compelling customer value proposition, and witty, humorous in-store signage and advertising campaigns. The Ollie’s motto of “Good Stuff Cheap” draws an attractive customer base of “treasure hunters” to the store to make repeat purchases. Ollie’s offers a unique shopping experience distinct from those of traditional department stores (a.k.a. “fancy stores”) and mass market (e.g. Walmart) with significant cost savings to the consumer. The fun and distinctive signage throughout the store and “treasure hunting” atmosphere lends itself to a customer experience that drives customers to buy now (“when it’s gone, it’s gone”) and more frequently visit the store.

Great Quality/Low Cost: A key element is Ollie’s ability to leverage its stock of merchandise from top manufacturers into real savings for customers. The Ollie’s motto of “Good Stuff Cheap” also applies to their procurement strategy as a key success factor for their operating model is the ability to cheaply source recognized, name-brand merchandise to provide value for the consumer. Namely, their ability to continuously attract customers is largely contingent upon their ability to continuously source closeouts, overstocked and salvaged merchandise through a variety of channels, including rather creative ones, e.g. bankruptcy sales.

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White Space Opportunity: With more than half the country untouched, Ollie’s Bargain currently sits at 235 stores within 19 states. All stores are currently on Ollie’s has proven portability of their store model as they entered 9 new states from 2011-2016 and opened 129 net new stores. Ollie’s has expanded contiguously to leverage brand awareness and marketing investments. In return, Ollie’s can expand their store base by ~725 stores to 950 stores, ~4.25x current store base.

Real Estate Pipeline: Availability of real estate selections is going up for Ollie’s, this gives them a strong position to increase their store location count over the long term. Ollie’s is benefiting from their real estate site selection because it capitalizes on ample supply of low-cost second generation real estate. This is a factor for Ollie’s to continue to meet all their quarterly and yearly store quotas.

Ollie’s Army Membership Growth: Ollie’s Army membership levels continue to grow ahead of sales and army members continued to significantly outspend non-members. The rollout of coupon serialization during the quarter allows Ollie’s to begin to better understand the behaviors of Ollie’s Army members on an individualized basis. Ollie’s loyalty program has experienced 30% CAGR over the last five years, while it currently stands at 7.3 million Army members versus 5.6 million at the end of Q4 last year. The average members are spending about 40% more in the non-Ollie’s Army members. The sales of the loyalty program make up approximately 65% of the company sales.

Recession Proof: The economy began growing in 2009, and has averaged 2.1% annual growth since then. Ollie’s business model is insulated from economic downturns as they are one of America’s largest retailers of closeouts, excess inventory, and salvage merchandise. Attractively, people turn to this store that offers the most for the least.

Business Description

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    Company Description: Ollie’s Bargain Outlet Holdings, Inc. (NASDAQ: OLLI), went public in July 2015, and is a highly differentiated and fast-growing, extreme value retailer of brand name merchandise at drastically reduced prices. The Company offers deals on closeouts, excess inventory and salvage merchandise. Ollie’s is known for their assortment of products offered as Good Stuff Cheap®, where they offer customers a broad selection of brand name products in eight categories. Ollie’s constantly changing merchandise assortment is procured by a highly-experienced merchant team, who leverage deep, long-standing relationships with hundreds of major manufacturers, wholesalers, distributors, brokers and retailers. Ollie’s Army is Ollie’s Bargain Outlet’s customer loyalty program. Ollie’s main operating function revolves around a fun and engaging treasure hunt shopping experience.

    Operating in Following States: Pennsylvania, New Jersey, Maryland, Delaware, Ohio, Virginia, West Virginia, North Carolina, Kentucky, New York, Connecticut, Tennessee, South Carolina, Indiana, Georgia, Alabama, Florida, Michigan, and Mississippi.

Exhibit 2: Geographic Expansion Opportunities

    Ollie’s Trademarks: Ollie’s owns several state and federally owned registered trademarks related to its brand, including “Ollie’s,” “Ollie’s Bargain Outlet,” “Ollie’s Army” and “Real Brands! Real Bargains!” In addition, OLLI maintains a trademark for the image of Ollie, the face of its company. OLLI has a license and co-existence agreement, as well as state trademark registrations, for “Good Stuff Cheap.” OLLI also owns registered trademarks for many of its private labels such as “American Way,” “Steelton Tools,” “Sarasota Breeze” and “Commonwealth Classics” among others.

                                                    Product Categories: Ollie’s breaks down their products into two categories:

Brand name and closeout merchandise: (approximately 70% of merchandise purchases in fiscal year 2016). Ollie’s experienced merchant team purchases merchandise which includes overstocks, discontinued merchandise, package changes, cancelled orders, excess inventory and buybacks from retailers and major manufacturers.

Non-closeout goods/private label: (approximately 30% of merchandise purchases in fiscal year 2016). Ollie’s sells their brand name merchandise with non-closeout and private label merchandise. Ollie’s also sells licenses for private label products that use recognizable celebrity names like Marcus Samuelsson, Josh Capon and Kasey Kahne, or brand names like Country Living, Magnavox, Popular Mechanics and Wells Lamont. Ollie’s routinely evaluate the quality and condition of these private label goods to ensure

that they are delivering a high-quality product at a great price.

Product Segments: Ollie’s derives its revenue from the following goods (% of all revenue):

Housewares: cooking utensils, dishes, appliances, plastic containers, cutlery, storage and garbage bags, detergents and cleaning supplies, cookware and glassware, fans and space heaters, candles, frames and giftware;

Food: packaged food including coffee, bottled non-carbonated beverages, salty snacks, condiments, sauces, spices, dry pasta, canned goods, cereal and cookies;

Books and stationery: novels, children’s, how-to, business, cooking, inspirational and coffee table books along with DVDs, greeting cards and various office supplies and party goods;

Bed and bath: household goods including bedding, towels, curtains and associated hardware;

Floor coverings: laminate flooring, commercial and residential carpeting, area rugs and floor mats;

Electronics: air conditioners, home electronics, cellular accessories and as seen on TV;

Toys: dolls, action figures, puzzles, educational toys, board games and other related items; and

Other: hardware, personal health care, candy, clothing, sporting goods, pet products, luggage, automotive, seasonal, furniture, summer furniture and lawn & garden (Exhibit 3).

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Sports marketing, charity and community events: Ollie’s sponsor s professional and amateur athletics including Major League Baseball, NASCAR, National Hockey League, NCAA basketball and football, as well as various local athletic programs. Ollie’s is dedicated to maintaining a visible presence in the communities in which their stores are located through the sponsorship of charitable organizations such as the Children’s Miracle Network, Cal Ripken, Sr. Foundation and the Kevin Harvick Foundation. We believe these sponsorships promote our brand, underscore our values and build a sense of community.

NASCAR Sponsorship: In the 2006 NASCAR Busch Series, Ollie’s sponsored the #43 car of Kertus Davis at Dover. The following year, the company sponsored Jamie McMurray’s #37 car in the same Busch Series race held at Dover. In 2008, Ollie’s sponsored the Ollie’s Bargain Outlet 360 Challenge with Kasey Kahne, Dave Blaney and Tony Stewart. In 2010 Ollie’s sponsored the #33 Chevy Silverado driven by Ron Hornaday for the Pocono Raceway truck series race. His team, Kevin Harvick Inc., has been sponsored by Ollie’s since the beginning of 2010. After much exposure during the 2012 Daytona 500, where Tommy Baldwin Racing’s Dave Blaney was leading at the time of the red flag, Ollie’s extended their sponsorship of the team’s #36 for later races

    Growth Strategy

Economic Growth: The increased disposable income for households, resulting from economic growth, has spurred higher spending on retail as consumers begin to worry less about having to look out for preferences and become more non-brand conscious. This gives Ollie’s the perfect niche market of bargain shoppers and a new opportunity to target the large middle class who previously were hard to reach because of their price sensitivity. “America has always loved a bargain, that’ll never go out of style,” Chief Executive Mark Butler said. Consumer spending constitutes approximately 70% of the economy, therefore the US GDP growth rate per year, as of Dec. 2016, of 3.47%, has led to a boost in consumer spending in industry’s like specialty retail stores, increasing the performances of companies, like Ollie’s, that draw in customers bouncing back from a recession and are receiving increased cash flows.

Increase Offerings of Great Deals: Ollie’s has increased market share since their IPO and geographic expansion. Furthermore, competitors with higher prices could further enhance Ollie’s value proposition moving forward, given the companies 25% – 60% price gap compared to traditional outlets. With a historic record of strong quarters, Ollie’s has increased inbound calls on deals and increased buying power and scale from growth. This has led to an increased in vendors selling merchandise to Ollie’s because of their continued focus on building and developing their merchant team.

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Expand Store Base: Ollie’s stores are supported by two distribution centers in York, PA and Commerce, GA, which Ollie’s believes can support about 950 stores. Each store averaging approximately 33,000 square feet. Based on Ollie’s franchise like store model, they have reported a 55% return on investment target for new stores. Once Ollie’s begins to tap into their national geographic potential, they estimate their current base store count estimate to increase by 5 bps. During the 2015 fiscal year, Ollie’s opened 28 stores and closed 1 store and opened 21 stores in fiscal 2016 to date (Exhibit 4).

Operational Improvements and Supply Chain: Ollie’s is continuously improving its logistics and supply chain through efficiency gains, meaning store assortment of products, higher fulfillment, and store replenishment. The company has two distribution centers in York, Pennsylvania and Commerce, Georgia, which it believes can support 375 to 400 stores, carrying a variety of the brand names sold at Ollie’s (Exhibit 5). These centers and new systems such as warehouse management may rise inventory turnover and boost margins as there is a lesser need for safety stock, fewer markdowns and more associate time spent with shoppers.

Industry and Peer Analysis

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Retail industry: An estimated two-thirds of the U.S. GDP comes from retail consumption. With broader retail market growth at a pace of 3% annually, many companies are searching for ways to increase profit while expanding growth and market share. Ollie’s manages to sell its merchandise at a 70% discount to department stores; thus, indicator of a good defensive stock during bad market conditions. The proliferation of lower-priced stores is largely due to the economy. Ollie’s business model is insulated from economic downturns as they are one of America’s largest retailers of closeouts, excess inventory, and salvage merchandise. Attractively, people turn to this store that offers the most for the least. The discount stores industry has proven to be an excellent industry over the trailing five-year period. Discounters have been benefiting from increasingly cost-conscious consumers focused seeking out lower-priced goods when buying everyday necessities. Demand for general merchandise carried by discounters will generally remain stable. There is a very solid consumer base. There is anticipation for a gradual recovery in the economy, which leads to more discretionary income which could both be beneficial and detrimental to Ollie’s. In the discount market, retailers compete heavily on low prices, as core assortments of basic consumables tend to be the same.

Retail 2017 Trends: These are the best of times for retail. The industry is coming off a record-setting holiday shopping season that formally kicked off with Black Friday online sales of $3.34 billion — an all-time high, up 21.6% year over year. In all, holiday spending surged 3.8% to $196.1 billion in 2016, the strongest rate of growth since 2011, giving Ollie’s a great platform to over perform in. Both physical and online channels witnessed growth, with online spending soaring 17.1% over the prior year. Ollie’s has tremendous potential in expanding their operations online allowing for future promising gains. A competitive advantage for Ollie’s is the performance of the rest of the industry. Some competitors are facing the worst of times for retail. National chains including Macy’s, Sears, J.C. Penney’s, Kohl’s and Barnes & Noble all suffered absolutely brutal holiday seasons, calling into question what — if anything — they can do to right the ship and compete more effectively in an increasingly digital world.

Competitors: Ollie’s competes with a diverse group of retailers including discount, closeout, mass merchant, department, grocery, drug, convenience, hardware, variety, online and other specialty stores. You could classify the following companies competitors of Ollie’s: Dollar General (NYSE:DG), Whole Foods (NASDAQ:WFM); Big Lots (NYSE:BIG); Walmart (NYSE: WMT); T.J. Maxx (NYSE: TJX); Costco (NASDAQ: COST); Amazon (NASDAQ: AMZN); and Dollar Tree (NASDAQ: DLTR). Ollie’s is intelligently growing their revenues without compromising on profit margins. The company’s operating margin has been growing, and is better than its peers; Ollie’s has an operating margin of 10%, higher than competitors’ average operating margin of 6%. Ollie’s is on track to capitalizing on its available growth opportunities, in the highly competitive discounted retail industry, which will offset into explosive growth for its future financial performance. Ollie’s ongoing efforts to improve the level and range of extremely discounted products offered at their stores will not only keep existing customers interested in visiting its stores, frequently, but they will also serve as an important mean of drawing additional traffic to its stores (Exhibit 6).

Retail Industry Outlook: Population growth and consumer spending drive demand. The profitability of individual companies depends on efficient supply chain management, effective merchandising, and competitive pricing, which Ollie’s has successfully been

operating. Ollie’s has a competitive advantage as measures of consumer sentiment are all hitting highs, which will lead to growth for our economy this year. Excluding gasoline, retail sales in 2017 are expected to rise by 4.2%, better than the 3.8% growth rate in 2016. A pickup in merchandise sales will more than balance out an expected slowing in the growth of motor vehicle sales and restaurant meals. Strong retail sales growth in January and a decent February indicate that consumers are still bullish on the economy. January’s 0.9% monthly jump in core retail sales (which exclude autos, gasoline, building materials and food services, the volatile categories) and February’s 0.1% increase indicate positive momentum for the industry Ollie’s falls in, thus a good indicator that Ollie’s will be meeting/ exceeding their expectations for the upcoming fiscal year of 2017 (Exhibit7).

Competitive Positioning

“Good Stuff Cheap” Ever changing product assortment at drastically reduced prices: Ollie’s stores offer something for everyone across a diverse range of merchandise categories at prices up to 70% below department and fancy stores and up to 20-50% below mass market retailers. Ollie’s product assortment frequently changes based on the wide variety of deals available from the hundreds of brand name suppliers they have relationships with.

 

Position Retail Ollie’s
Founder/CEO 39 34
EVP/CFO 24 13
Merch. VP 41 16
Distr. VP 25 11
Real Estate VP 39 31
Mktg. VP 10 10
CIO 42 5

Highly experienced and disciplined merchant team: Ollie’s 16-member merchant team maintains strong, long-standing relationships with a diverse group of suppliers, allowing them to procure branded merchandise at compelling values for their customers. This team is led by five senior merchants, including Mark Butler, and has over 112 years of combined industry experience and 95 combined years of experience at Ollie’s (Exhibit 8). Ollie’s has been doing business with our top 15 suppliers for an average of 13 years, and no supplier accounted for more than 6.0% of their purchases during fiscal year 2016.

Distinctive brand and engaging shopping experience: Ollie’s distinctive and often self-deprecating humor and highly recognizable caricatures are used in their stores, flyers, mailers, website and email campaigns. They attempt to make their customers laugh as they poke fun at themselves and current events. Ollie’s believes this approach creates a strong connection to their brand and sets them apart from other, more traditional retailers. Ollie’s “semi-lovely” stores feature these same brand attributes together with witty signage in a warehouse format that create a fun, relaxed and engaging shopping environment. Ollie’s believes that by disarming our customers by getting them to giggle a bit, they are more likely to look at and trust our products for what they are—extremely great bargains. Ollie’s offer a “30-day no hard time guarantee” to overcome any skepticism associated with their cheap prices and to build trust and loyalty, because if their customers are not happy, Ollie’s is not happy. They also, welcome customers to bring back their merchandise within that timeframe for a “no hard time” full refund.

Extremely loyal “Ollie’s Army” customer base: Ollie’s best customers are members of our Ollie’s Army customer loyalty program, which stands at 7.3 million members as of January 28, of 2017. For fiscal year 2016, over 65% of our sales were from Ollie’s Army members, and we have grown our base of loyal members by 31.2% in fiscal year 2016. Ollie’s Army members spend approximately 40% more per shopping trip at Ollie’s and typically shop more frequently than non-members. Ollie’s identify their target customer as “anyone between the ages of 25-70 with a wallet or a purse” seeking a great bargain.

Founder-led management team: Ollie’s leadership team, directed by co-founder, Chairman, President and Chief Executive Officer, Mark Butler, has guided the organization through its expansion and has positioned Ollie’s for continued growth. Mark Butler has put together a talented and dedicated team of executives with an average of 24 years of retail experience, including an average 12 years of experience at Ollie’s. Ollie’s senior executives possess extensive experience across a broad range of disciplines, including merchandising, marketing, real estate, finance, store operations, supply chain management and information technology. By encouraging equity ownership and fostering a strong team culture, Ollie’s has aligned the interests of their employees with those of their stockholders. These factors result in a cohesive team focused on sustainable long-term growth.

Seasonality: Ollie’s business is seasonal in nature and demand is generally the highest in their fourth fiscal quarter due to the holiday sales season. To prepare for the holiday sales season, Ollie’s orders and keeps in stock more merchandise than they can carry during other times of the year and generally engages in additional marketing efforts. They expect inventory levels, along with accounts payable and accrued expenses, to reach their highest levels in their third and fourth fiscal quarters in anticipation of increased net sales during the holiday sales season. As a result of this seasonality, and generally because of variation in consumer spending habits, Ollie’s experiences fluctuations in net sales and working capital requirements during the year. Because Ollie’s offers a broad selection of merchandise at extreme values, they believe they are less impacted than other retailers by economic cycles which correspond with declines in general consumer spending habits and because of this Ollie’s will benefit from periods of increased consumer spending.

 

Financial Analysis

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Comparable sales: Ollie’s comparable sales were up 2% to match consensus and total sales increased 16% to $283M on a higher store count. The increase in comparable store sales was driven by an increase in the average basket size. Ollie’s opened two new stores during the quarter, ending with 234 stores in 19 states and increased in-store count of 15.3% year over year (Exhibit 9)

Revenue Growth: Ollie’s Bargain is dominating over its competitor as they have outperformed Big Lots for the last 8 consecutive quarters in revenue growth. Ollie’s has averaged an 18% growth rate since IPO in 2015. In contrast, Big Lots has averaged below 1% revenue growth rate since April of 2015. Ollie’s has a very direct and sustainable path to sales growth, both organically and through new units, resulting in explosive results when tracking revenue growth as they continue to stay on track of their store openings. Ollie’s has targeted, on average, a 55% return on investment for new stores, contributing to the rapid revenue growth

Profit Margin: When comparing profit margins since Ollie’s IPO in 2015, they have outperformed Big Lots consistently even while facing the challenges of a cyclical business cycle. Ollie’s has averaged a 5.52% profit margin vs Big Lots 2.56% profit margin. As Ollie’s continues to build relationships with their vendors, they also manage to lower the costs allowing these profit margins to rise contributing to their revenue growth to outperform Big Lots performance (Exhibit 10).

EPS: Ollie’s Bargain when compared to Big Lots, outperformed in eps growth. Ollie’s averaged 20% EPS growth this quarter compared to Big Lots 12.4% growth. Both retailers face the risk of having excess inventory or seasonal inventory back up due to the nature of the business and the industry it is in. Ollie’s is well positioned to withstand some of the major structural challenges affecting most retailers, as they have reported positive eps growth for the past 8 consecutive quarters. This trend in eps growth is expected to continue as Ollie’s has a track record of positive EPS growth. EPS growth for the fiscal year of 2016 is 36.30% and EPS growth for next year is expected to reach at 16.51%. Ollie’s EPS growth in past five years was 13.90%, while EPS growth in next five years is projected to arrive at 19.35% (Exhibit 11).

Leverage and Liquidity: With debt at a relatively low, Ollie’s debt is 10.87% of its enterprise value compared to an overall benchmark of 25%. Compared to the industry Ollie’s is in, the peer median is currently 41.87%. With a well-cushioned interest coverage level of 12.38x, Ollie’s has the capability to borrow quickly. To Ollie’s advantage, they are able to increase their confidence in their credit line availability because they are backed by a private equity firm called CCMP Capital Advisors.

Strong EBITDA Levels: Ollie’s Adjusted EBITDA increased 21.6% to $45.2 million. This is the company’s eighth consecutive quarter with EBITDA increase quarter over quarter. The EBITDA growth reflects the company’s continued focus on low cost producer status and industry leading patient care, quarter over quarter. The low cost for production can have some major profit margins for the near and far future of the company’s growth.

Pro Forma

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The Pro Forma Income statement exhibited was constructed to estimate Ollie’s revenues and earnings per share growth for the four quarters of Fiscal 2018. All figures were calculated using a weighted average of personal projections derived from the information in the Financial Analysis section as well as historical growth records, management predictions, and analyst forecasts.

Revenue Growth: As shown in the pro forma statement above, the revenue growth for Fiscal 2018 will be 18.13%, which is up 1.33% from Fiscal 2017 growth of 16.8%, and is expected to continue in this increasing trend. For the Fiscal 2017 year, Ollie’s saw comparable store sales increase 3.2%; Guidance from management shows same store sales growth to be about 2% – 4% including the impact of store expansion, which is in line with my estimates. The increase in net sales was driven by a 2% increase in comparable store sales this past quarter and a 15.3% increase in store count over the fourth quarter of fiscal 2015.

Top Line Growth: Ollie’s has developed a reputation for beating earnings estimates by beating estimates for every quarter since its IPO in July 2015. Through its store count growth and organic growth, the company has been able to maintain stable earnings growth year over year. I predict a significant increase in top line growth for Ollie’s due to their steady increase in stores entering new states and the average sales in their system wide sales, as well as increases in national advertising and marketing, brand recognition, and technology investments, and the penetration of new markets.

Gross profit: Ollie’s gross profit increased 14.7% to $113.4 million in the fourth quarter of fiscal 2016 from $98.8 million in the fourth quarter of fiscal 2015 and gross margin decreased 60 basis points to 40.0% from 40.6% in the same respective periods. The gross margin decrease was the result of a lower merchandise margin, partially offset by a decrease in transportation and distribution costs as a percentage of net sales.

Operating income: Ollie’s operating income increased 21.8% to $40.6 million in the fourth quarter of fiscal 2016 from $33.3 million in the fourth quarter of fiscal 2015. As a percentage of net sales, operating income increased 60 basis points to 14.3% in the fourth quarter of fiscal 2016.

Cost of Revenue: The cost of revenue as a percentage of revenue was calculated by averaging the proportions of each quarter year over year from the last two years. Cost of Goods Sold is directly linked to the profitability of the company through gross margin. Ollie’s gross margin for the three months ended in Jan. 2017 is calculated as 40.02%. Ollie’s cost of revenue has been relatively stable over the last two years remaining in a range of about 12%-25% of total revenue. Therefore, it is appropriate to expect that this trend will continue throughout the remainder of 2017 and the start of 2018.

Operating Expense: Ollie’s operating expenses have yielded a historical growth rate of about 3-5% over the last two years’ quarter over quarter. During this period, operating expenses as a percentage of total revenue ranged between 13% and 21.5% averaging about 17% per year. Therefore, after adding the growth rate to the historical average, we can expect the operating expenses for Fiscal 2018 to be about 80% of total revenue.

Income Taxes: Income taxes were estimating by determining the provision for income taxes as a percentage of income before taxes and then averaging them to get a historical average. It is assumed that there will not be any significant changes to the income tax provision in Fiscal 2018.

Earnings per Share Growth: Personal estimates of EPS growth were obtained through careful observations of historical movements, forecasted revenue growth rates, guidance from Ollie’s management, and assuming a constant 60.1 M in shares outstanding.

Net Income: The bottom line growth for Ollie’s has thrived due to their focused efforts on increasing their store count and expanding into states beyond the east side of the country. Although their revenue has increased at such a strong rate system-wide, their costs have increased at a much smaller rate. By moving to a franchise-like heavy structure, boosting national marketing campaigns, and heavier usage of its online Point of Sale system, I predict Ollie’s will increase growth in its bottom line.

Valuations

In this section, I estimate the fair values of Ollie’s stock. It should be noted that all input data were derived from historical company data and pro forma estimates.

Residual Income Model: The residual income model values a security by using a combination of a company’s current book value per share and the present value of expected future residual income. Using a current book value per share of 10.72, a required rate of return of 10.91%, a growth rate of 8.98%, and a return on equity of 15.35% I could conclude the following: I found the fair value price to be $35. 38 and undervalued 5.30%.

Implied P/E: The price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. For the Implied P/E model the following figures were used to derive to a conclusion: a earnings per share (one year hence) of .96; a return on equity of 15.35%; a sustainable growth rate of 10%; and a required rate of return of 10.91%. Based on these figures, the stock’s fair value computed to be $36.77. An undervaluation of 9.43%.

Average Fair Value: After averaging both valuation metrics, Ollie’s fair value was found to be $36.08. This reflects and undervaluation of 7.38%.                                                

Risk Factors

General Economic Conditions: The current state of the business cycle is one of the most important factors for consumer cyclical stocks as their success depends on the demand and amount of money spent at their stores from consumers. Ollie’s being a specialty retail company, depends heavily on the state of the economy and can be adversely affected by reduction in consumer discretionary purchases from all demographic areas.

Consumer Confidence: Reduced customer confidence and spending cut backs may result in reduced demand for Ollie’s merchandise, including discretionary items, and may force Ollie’s to take inventory markdowns. Reduced demand also may require increased selling and promotional expenses. Consumer confidence is a significant measure as to how consumers see the economy in the near future. The University of Michigan measurers this metric and recently reported a level of 96.3 for the month ending February 2017, which is up 5% from February 2016, but is down 2.2% from January 2017, which reported 98.5. This recent downturn from month to month could be a result from uncertainty from a coming Fed meeting and other global economic factors such as uncertainty in the oil industry.

Unemployment: Unemployment levels are also an important factor that can affect future financial performance. The current level of unemployment is 4.7%, down from 4.9% a year earlier, which is the lowest in the last two years and is near full employment levels. This is a good indicator for future success for Ollie’s because there are more people employed meaning more money can be spent in the whole economy, meaning a portion should follow to Ollie’s.

Opportunistic Buying: Ollie’s business is dependent on their ability to strategically source a sufficient volume and variety of brand name merchandise at opportunistic pricing. Ollie’s does not have significant control over the supply, design, function, cost or availability of many of the products that they offer for sale in their stores. A substantial amount of store products are sourced by suppliers on a closeout basis or with significantly reduced prices for specific reasons, Ollie’s is not always able to purchase specific merchandise on a recurring basis.

Retaining Loyalty Members: Ollie’s depend on their loyal customer base, particularly members of Ollie’s Army, for their consistent sales and sales growth. Competition for customers has intensified as competitors have moved into, or increased their presence in, discount retail geographic markets and from the use of mobile and web-based technology that facilitates online shopping and real-time product and price comparisons. Ollie’s expects this competition to continue to increase. Ollie’s competitors may be able to offer consumers promotions or loyalty program incentives that could attract Ollie’s Army members or divide their loyalty among several retailers. If Ollie’s is unable to retain the loyalty of their customers, their net sales could decrease and they may not be able to grow their store base as planned.

Expansion into New Markets: Ollie’s has been developing nationally and the company continues to open stores in new markets in the United States too. In some of these markets there may be limited or no market recognition of Ollie’s brand. Those markets may also have competitive conditions, consumer tastes and discretionary spending patterns that are different from those in our existing markets. As a result, those new stores may be less successful than stores in Ollie’s existing markets. With new stores opening, Ollie’s may find it more difficult in new markets to hire, motivate and keep qualified employees who can project their vision, passion and culture. Stores opened in new markets may also have lower average stores sales than stores opened in existing markets. Sales at stores opened in new markets may take longer to ramp up and reach expected sales and profit levels, and may never do so, thereby affecting overall profitability.

Government Regulation: Ollie’s is subject to labor and employment laws, including minimum wage requirements, laws governing advertising, privacy laws, safety regulations and other laws, including consumer protection regulations that regulate retailers and govern product standards, the promotion and sale of merchandise and the operation of stores and warehouse facilities.

International Merchandise: Ollie’s sources a portion of their products from outside the United States. The U.S. Foreign Corrupt Practices Act and other similar anti-bribery and anti-kickback laws and regulations generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business.

Adverse Events: Ollie’s generally recognizes their highest volume of net sales in connection with the holiday sales season, which occurs in the fourth quarter of their fiscal year. In anticipation of the holiday sales season, Ollie’s purchases substantial amounts of seasonal inventory and hire many part-time associates. Because a significant percentage of their net sales and operating income are generated in their fourth fiscal quarter, Ollie’s has limited ability to compensate for shortfalls in their fourth fiscal quarter sales or earnings by changing our operations or strategies in other fiscal quarters. Adverse events, such as deteriorating economic conditions, higher unemployment, higher gas prices, public transportation disruptions, or unanticipated adverse weather conditions could result in lower-than-planned sales during the holiday sales season. If Ollie’s fourth fiscal quarter sales results were substantially below expectations, they would realize less cash from operations, and may be forced to mark down our merchandise, especially in their seasonal merchandise, which could have a material adverse effect on our business, financial condition and results of operations.

Failure to protect Brand Name: Ollie’s may be unable or unwilling to strictly enforce their trademarks in each jurisdiction in which we do business. Also, Ollie’s may not always be able to successfully enforce their trademarks against competitors or against challenges by others. Some competitors may have larger brand recognition due to their market cap, which may be difficult for Ollie’s to compete against. Ollie’s failure to successfully protect their trademarks could diminish the value and efficacy of their brand recognition and could cause customer confusion, which could have a material adverse effect on Ollie’s business, financial condition and results of operations.

 Recommendation:

Investing in Ollie’s Bargain Outlet Holdings will provide the Roland George Investments Program portfolio with an opportunity to capitalize on the growing ‘bargain’ movement. Given the current trajectory towards an expanding economic cycle, investing in a consumer cyclical/ consumer discretionary stock such as specialty retail, and more specifically discount stores, will decrease the overall riskiness of the program’s portfolio. The specialty retail industry may be particularly attractive as typical retail stores have done poorly in recent quarters and with the current administration pushing for less regulation, more tax cuts for the middle class, increased spending, and rising interest rates that will inhibit large ticket items. Therefore, I recommend the program to BUY 2,950 shares of Ollie’s stock.

 

 

 

 

 

 

 

 

 

 

 

 

 

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