Hold Your Nose And Sell Ollies

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I’ve been a big fan of off-price retailer Ollie’s (NASDAQ:OLLI) for years. The company’s model speaks to value-conscious consumers and has proven to work in a variety of locations and under lots of different economic circumstances. I recommended the stock back on March 23rd with shares at just $39, noting that the selloff had been way overdone. However, with the stock now back at $91, I fear we’ve now swung to the other extreme, and it is time to take profits.

Q1 results defy expectations

Ollie’s reported first-quarter earnings on May 28th and the results were simply astonishing. At a time when some retailers are simply trying to stay in business, Ollie’s is thriving. Total revenue was up 7.5% to $349 million during a quarter when massive economic disruption took place globally. The increase in sales was driven entirely by new stores, as comparable sales declined 3.3%. That’s down from a 0.8% gain in the year-ago period, but given the landscape that we find ourselves in today, countless retailers would do anything for a 3.3% comparable sales decline.

Ollie’s said it saw significant volatility in comparable sales during the quarter, as traffic initially plummeted, but then rebounded strongly as stimulus checks began to arrive. With Ollie’s focused on providing a value-oriented, no-frills shopping experience, this makes sense. However, one has to wonder what the company’s sales will look like when the stimulus checks have run out, which is a risk in my view.

Margins continue to hold up reasonably well all things considered, as gross profit was up 5.7% to $140 million in Q1. Gross margin as a percentage of revenue was off 70bps to 40.2% as mix shifted towards consumables, which carry lower margins for Ollie’s. Lower-than-planned total revenue also deleveraged certain supply chain costs, but that should go away as sales levels return to normal.

Operating income was up 5.4% to $43 million in Q1, with operating income as a percentage of revenue falling just 10bps to 12.3%. Net income was up 6.7% to $32 million, or $0.49 per share, up from $0.46 per share in the year-ago period. Ollie’s defied the odds in Q1, and shareholders have been rewarded as such.

Ollie’s has managed to maintain its outstanding balance sheet, with $119 million in cash as of the end of the quarter against no debt. Inventory was up 4.5% year-over-year to $344 million, or about one quarter’s worth of revenue. Capex is carrying on as normal as well as Ollie’s has no reason to slow down on that front.

What to do then?

All of that is very nice, and Ollie’s deserves a lot of credit for not just surviving, but thriving in a very difficult environment. It is these characteristics that had me so very bullish a couple of months ago under $40; it was quite obvious Ollie’s would do well in an environment where value is king for the consumer.

Ollie’s is executing on this strategy and, from what I can tell, is basically carrying on as though nothing has happened. No higher compliment could be paid to a retailer at this point in time, and I continue to admire the way Ollie’s executes quarter after quarter.

The problem is that this outperformance appears to me to have been priced in some time ago, as Ollie’s has exceeded even my wildest expectations in terms of near-term share price performance.

Source: Seeking Alpha

The stock is trading for a staggering 40 times this year’s earnings, and while I freely acknowledge that Ollie’s continues to be a best-of-breed retailer with lots of growth runway in front of it, enough is enough. Forty times earnings is generally reserved for companies with extremely high margins and recurring revenue, like software, for instance, and not general merchandise retailers. Ollie’s is the best in its class, but should we grossly overpay for the stock because of this? I certainly don’t think so.

Ollie’s is slated to hit high-teens EPS growth this year and next year, so no COVID-19 discount on the earnings multiple is necessary. With second-quarter sales off to a strong start, per management’s guidance, we can fully expect Ollie’s to hit these numbers, as it has always delivered in the past.

However, at such lofty multiples of 40 times this year’s earnings and 33 times next year’s, earnings growth should be much higher than it is projected to be at present. Buyers today are paying 31 times earnings that won’t occur for another two and a half years, give or take, for a company with long-term growth potential in the low-teens area. Short-term outperformance shouldn’t be extrapolated into forever, which is what I believe is happening now.

I’ve been a big fan of Ollie’s since it went public several years ago and have let my thoughts be known publicly here on SA. I still like Ollie’s. I like its balance sheet, its margins, and its growth potential. But there comes a point when all of that is priced in and we are well past that point. I see fair value for Ollie’s in the high-20s in terms of earnings multiples based upon its growth projections, so at 40 times earnings, shares are way too expensive. I’m not bearish on Ollie’s fundamentals, but I cannot help but think the stock needs to come way down from here to be a buy once more.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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