3 Reasons Why Ollie’s Bargain Outlets Is a Buy

The good times look like they may continue a while longer for investors in Ollie’s Bargain Outlet Holdings Inc (NASDAQ: OLLI) after the company reported its 2018 first-quarter earnings. In the quarter, the company’s total net sales increased 21%, to $275.7 million, and adjusted earnings per share (EPS) increased 64%, to $0.41.

In addition to the strong top- and bottom-line growth, the company’s balance sheet continues to improve. The company ended the quarter with just a little over $24 million in total borrowings; at the end of 2017’s first quarter, that same total was $129 million. Finally, Ollie’s also slightly raised its full-year revenue and earnings guidance.

What’s driving this robust growth? I reviewed the conference call, and there seems to be at least three catalysts that make this hot stock still a buy: a rapid rise in store count, margin expansion, and a growing customer loyalty program.

Ollie’s Bargain Outlets has made a killing by selling “Good Stuff Cheap.” Image source: Getty Images.

Store count rising

Ollie’s ended the first quarter with 276 locations in 21 states, a nearly 16% increase year over year. During the quarter, the company opened its first two stores in Arkansas and is scheduled to open its first store in Louisiana later this month, making it the 22nd state in which the company will operate stores.

In the conference call, CEO Mark Butler said the company was on track to open 36-38 stores this year, in line with its long-term goals of increasing the number of its stores by a mid-teen percentage each year. The new stores also continue to perform above expectations. In what has become a common refrain in recent conference calls, CFO Jay Stasz said, “Our new stores continued to perform above our expectations across both new and existing markets.”

Butler said the company continues to see a “strong pipeline of leasing opportunities,” something management has alluded to in the past, an opportunity that may be aided by the store closings of so many traditional brick-and-mortar retailers. He maintains that the company can still expand to 950 stores across the country — almost 3.5 times as many locations as it has now — giving it a long runway for growth.

Margin expansion

One of the things that most stood out from Ollie’s strong first quarter was the expansion of its margin rates. Gross margin improved to 40.9%, operating margin to 13.1%, and adjusted EBITDA margin to 14.9%. Among the things credited to margin growth was an improvement in merchandise margin, which was partially offset by higher supply-chain costs, according to management. While supply-chain costs are expected to continue to increase, management is maintaining an annual gross margin rate of 40.1%.

Butler said the quarter’s strong margin was helped immensely by a buying environment that he called “quite vibrant.” He said the company was able to “leverage” that environment and “increase the margin when and where possible.”

The bargain brigade

Ollie’s Army — what Ollie’s affectionately calls its customer loyalty program — now has almost 9.3 million members, and the company is continuing to grow membership faster than it grows stores. This is important because members spend far more than non-members, as Ollie’s Army now accounts for about 70% of sales.

Butler believes this membership growth will only ramp up as the company rolls out new features, such as a mobile app and army-inspired ranks, which will further engage its customer base. During the conference call, Butler said:

As we talked about before, we’re rolling out some key initiatives for the Army. We’re on target to launch Ollie’s mobile app in the second quarter. This app will make it easy for members to track their rewards and allow us to communicate the latest and the greatest deals. We’ll also roll out ranks where Ollie’s Army members will become one, two, or three-star generals, and receive different rewards and surprise offers based on their level of spending. These program improvements are designed to reward the loyalty of the Army and build lasting relationships with our Bargainauts.

Ollie’s stock not a bargain, but still a buy

Given the company’s full-year 2018 adjusted EPS guidance of $1.69 to $1.72, shares trade at a forward price-to-earnings (P/E) ratio of about 42 — and that’s high! Of course, investors generally can’t expect to find too many stocks of companies growing EPS at 60%-plus clips at bargain prices.

In a time when brick-and-mortar retailers are perpetually struggling as e-commerce continues to take market share, it almost seems counterintuitive to invest in an up-and-coming discount retail chain that doesn’t make a dime from online sales. Yet Ollie’s continues to benefit from the rest of the industry’s decline, as it can gain advantageous leasing spaces, bargain prices on inventory, and experienced retail employees looking for work as other stores shut down.

In addition, investors who have invested in Ollie’s have made out spectacularly well — the company’s stock is up almost 250% since its initial public offering in 2015.

When faced with investment choices like this, I often go back to Warren Buffet’s sage advice: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” While I do not yet own shares in Ollie’s, it’s on my short watch list and remains a pick on My CAPS page.

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Matthew Cochrane has no position in any of the stocks mentioned. The Motley Fool owns shares of Ollie’s Bargain Outlet Holdings. The Motley Fool has a disclosure policy.

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