Description

Thesis

We believe that OLLI is a commoditized retailer with no economic moat, no brand equity, no differentiated product and low barriers to entry. Since 2016, discount and off price retailers have been in a goldilocks environment of cheap backfill square footage available for new stores, abundant inventory due to department store and manufacturer malaise, benign wage inflation and little to no headwinds for the lower end consumer. We believe these factors are coming to an end and new headwinds such as higher freight and labor costs will emerge.  We find OLLI’s to be a compelling short at today’s levels. A rising cost environment coupled with an extremely lofty valuation leaves OLLI’s susceptible to any disappointment in expectations. We believe fair value is at $38. Using the group average 20x P/E on 2019 EPS of 1.90 implying 35% downside.

Company Overview

Ollie’s Bargain Outlet is a deep closeout retailer of brand name merchandise in a treasure hunt experience known for an assortment of “GoodStuff Cheap”.  The company offers a broad selection of brand name products, including housewares, food, books and stationery, bed and bath, floor coverings, toys and electronics.   As of 4Q17, the company operated 268 retail locations. Ollie’s sales by category include housewares (12.7%), food (12.7%), books & stationery (10.6%), bed & bath (10.1%), floor coverings (8%), toys (5.2%), electronics (6.7%) and other (33.9%), with 70% of purchases coming from closeouts, and 30% from non-closeout/private label.

Key Facts:  

·         Operates 268 stores in 20 states; opened 34 net new stores in 2017

·         OLLI is targeting 15%+ sq. ft. growth per year to 950 stores over time

·         In 2017 65% of Ollie’s sales came from its 8.1M Ollie's Army loyalty members membership as grown at 27.5% 6 year CAGR

·         Ollie’s customer by age and demographics, 78% of customers are older than 31 years of age, with 63% of Ollie’s Army members earning $50K per household.

·         Competition: Big Lots (BIG), Dollar Tree (DLTR), Dollar General (DG), Five Below (FIVE)

Inventory closeout tailwind fading

OLLI has been a significant beneficiary of a favorable inventory environment driven by weak retail and CPG company sales leading to elevated inventory levels over the past two years. As shown in the table below, retail inventory to sales rose sharply over the last several years as consumer spending was less robust than many retail and consumer packaging companies anticipated – leading to a sharp rise in inventory levels. As companies adjusted to the consumer environment over the past several quarters, inventories relative to sales have started to gradually decline. Based on recent company commentary, we believe inventories relative to sales will continue to decline.

Newell Brands recently commented in February at an industry conference that the mass channel inventory liquidation that impacted nearly all consumer goods companies over the last year was waning. In addition, Colgate management also commented on fading inventory issues.

“The mass channel inventory liquidation which has affected all consumer "goods companies over the last year or so begins to wane quite frankly in the second half of 2017 and I don't believe is really an issue for this dynamic in the back half – I mean the first half of 2018 and into the balance of the year.” – Mike Polk, Newell Brands CEO, February 2018

“The inventory destocking would seem to be behind us, and we’re building against the underlying growth in the categories going forward” —Colgate Palmolive, November 2017

The bull case on Olllie’s is that it is a secular growth story with double digit unit growth plus low to mid-single digit same store sales growth.  However, historically, the company has experienced volatile sales growth. As shown in the table below, OLLI’s same store sales have been flat to down in several quarters over the past 5 years. Considering OLLI’s has been operating in one of the most favorable environments for its business model and is “only” experiencing 3%-4% same store sales growth, we question how negative same store sales will be received when low cost inventory is no longer readily available. In our view, OLLI’s is a consensus long among many growth investors while other consumer focused investors have flocked to OLLI’s stock given its “safe haven” status due to its steady comparable sales recently and unit growth story – ultimately driving a materially upward move in OLLI’s valuation.

Consumer Headwinds

According to JPM analysis: gas prices would be up 6% year-over-year in 2018 equating to a $80 wallet headwind for the $30-$40k income core dollar store consumer on our math with every 10 cent increase in the average price per gallon an incremental $55 in annual spend at the $30-$40K income level. As you can see below from the Bloomberg Gasoline Index prices have started to move higher than JPMs initial assessment and are up over 10% yoy already in 2018, using their math that is approximately $231 in incremental annual spend.

Expense headwinds increasing

Wage Inflation:

Olli Q3 2015 Earnings Call: “with regards to any potential wage pressures we might see in the future, from a hiring perspective, we've looked at the impact of going to the $9 per hour rate. That impact on our business would be very, very immaterial and something that we would be able to manage through. If and when the wage impacts were to actually go to a $10 rate on our overall basis, that would cause a little bit more pain”

Freight Costs Rising:

The freight size is a real thing right now, and it's a component really of some of the driver shortages that we'll see how long that lasts. And where we are on diesel fuel, diesel fuel is sort of back to the future 2015. We're almost starting to the same price per gallon. – DLTR March 2018 Earnings call

We incurred higher freight cost in the third quarter as we expanded our pool of freight partners to maintain our service level. Third, we experienced high turnover levels at our warehouse that resulted in the use of an experienced higher cost third-party workforce. We expect these increases in freight and warehousing expenses to continue into Q4 as we continue to prioritize our service levels to our customers - PBH Feb 2018 Earnings Call

The more significant challenge is on inbound freight from a domestic standpoint. And we, like every other retailer that you've probably covered so far this earnings season, are paying attention to those costs very, very closely – BIG March 2018 Earnings Call

Conclusion:  

Ollie’s is a compelling short.  We think that there is significant risk to revenue growth and earnings expectations in 2018 and 2019.  As these expectations are reset, we expect the stock rerate significantly lower. Our base case is the stock should trade at $38. Using the group average 20x P/E on 2019 EPS of 1.90 implying 35% downside.

Catalyst

We believe that OLLI is a commoditized retailer with no economic moat, no brand equity, no differentiated product and low barriers to entry. Since 2016, discount and off price retailers have been in a goldilocks environment of cheap backfill square footage available for new stores, abundant inventory due to department store and manufacturer malaise, benign wage inflation and little to no headwinds for the lower end consumer. We believe these factors are coming to an end and new headwinds such as higher freight and labor costs will emerge.