As an investor, it’s important to be flexible in your thinking. When the fundamentals of a company change, for better or worse, your assessment of the firm must invariably change as well. Otherwise, you will make a lot of mistakes when buying and selling stock. Throughout the year, there are four times that companies reveal large amounts of data to their investors, and it’s during these times that investors would be wise to pay the most attention to what’s going on. One company that I was recently bearish on is Ollie’s Bargain Outlet Holdings (NASDAQ:OLLI), an extreme value retailer that sells things like housewares, bed and bath products, food, books and stationery, and more. But between the share price falling and a positive outlook from both analysts and management, I do think a more neutral stance is warranted. But of course, this comes with the caveat that current expectations actually come to fruition. The next opportunity for this will be when management releases financial results covering the final quarter of the company’s 2022 fiscal year. That will be on March 22nd of this year.
The picture looks set to improve
Back in the middle of November of last year, I took a big step in my assessment of Ollie’s Bargain Outlet Holdings. After previously having the company rated a ‘hold’, I decided to downgrade it to a ‘sell’. In addition to shares of the business looking a bit pricey, margins continued to show signs of deterioration. These two factors, combined with broader economic concerns that have made me a bit more cautious in recent months, led me to downgrade the company accordingly. So far, that call has proven to be effective. While the S&P 500 is down 2.3% since the publication of that article, shares of Ollie’s Bargain Outlet Holdings have seen a downside of 9.7%.
Over the years, Ollie’s Bargain Outlet Holdings has become dedicated to structurally preparing itself for long-term growth. Consider the most recent store count data. As of the end of the third quarter of the 2022 fiscal year, the business boasted 463 stores in operation. That was up from the 426 that the company had the same time one year earlier. But the company’s preparation for the future was not restricted only to store count. It has also been focused on growing its distribution network. After all, with its locations spread across 29 different states, a sizable and robust distribution network is imperative in order to operate efficiently.
At present, the firm’s stores are supported by three different distribution centers. These are located in Pennsylvania, Georgia, and Texas. However, the firm is actively expanding its Pennsylvania distribution center by adding 200,000 square feet of capacity that is expected to be available in the first half of this year. In addition to this, in October of last year, the business entered into a purchase agreement to buy a parcel of land in Illinois for the construction of a fourth distribution center. We don’t know exactly what costs will be involved on this front, nor do we have much of a timeline. But management said that once it’s built and the aforementioned expansion is completed, the business will have distribution capabilities to support over 700 stores. With management adding around 40 stores each year, that’s enough to cover roughly six years of growth.
I admire and highly value growth initiatives. But as I pointed out in my aforementioned article where I downgraded the firm, the business was experiencing some rather unpleasant pains. Fortunately, in the third quarter of last year that management reported on in December, that picture improved drastically. In addition to seeing revenue climb from $383.5 million to $418.1 million, thanks not only to the rise in store count, but also because of a 1.9% rise in comparable store sales, the business also saw margins improve somewhat. In that quarter, the net profit margin of the business was 5.52%. That’s down only marginally from the 6.05% reported for the third quarter of the 2021 fiscal year. The primary drivers behind the margin deterioration involved a contraction in the company’s gross profit margin from 39.8% to 39.4% that was driven by higher supply chain costs and a reduction in merchandise margins, as well as a rise in selling, general, and administrative costs from 29.7% of sales to 29.9%. This latter change was attributable to higher selling costs that more than offset cost-cutting initiatives.
Even though this margin deterioration looks bad, it’s actually a significant improvement over what the company saw for the first nine months of the year as a whole. Net income in the first nine months of 2021 was $112.7 million. It fell to $49.7 million in the first nine months of 2022. This translates to a reduction in the net profit margin from 9% to 3.89%. The primary culprit here seems to have been a contraction in the company’s gross profit margin from 39.8% to 35.2% because of higher supply chain costs. An increase in the selling, general, and administrative costs from 26.2% to 28.2%, driven by higher selling expenses, also hit the business. So in all actuality, in the third quarter of the year, the picture was much better than it had been the rest of the year. This can also be seen when looking at other profitability metrics. In the third quarter, the company saw a net operating cash outflow of $3 million. That compares to the $39.1 million net outflow experienced one year earlier. If we adjust for changes in working capital, cash flow managed to rise from $31.6 million to $33 million. And over that same window of time, EBITDA improved from $37.9 million to $39.5 million. Looking at the graphs in this article, you can see that these all represent significant improvements when compared to results for the first nine months of the year as a whole.
Somebody who remains bearish about the company may make the argument that the third quarter might have been an anomaly. But that is looking to be unlikely. I say this because both management and analysts have come out with guidance for the final quarter of 2022. Before we get to the bottom line, we should touch briefly on the top line. Right now, analysts anticipate revenue of $542.2 million. If this comes to fruition, it would represent a sizable improvement over the $501.1 million reported the same time one year earlier. Management, meanwhile, is forecasting something not too different. They believe that fourth-quarter revenue will be between $540 million and $550 million, with a midpoint that’s higher than what analysts anticipate. In addition to store openings impacting sales positively, management said that comparable store sales will range between being flat and being up 2% year over year. That shows continued improvement since much of last year was plagued by declining comparable store sales.
On the bottom line, the current expectation is for earnings per share of $0.79. That would actually represent an improvement over the $0.71 per share reported for the final quarter of the 2021 fiscal year. Management, meanwhile, believes that earnings per share will come in somewhere between $0.78 and $0.83. It is important to keep in mind the impact that share buybacks will have on the firm. In the third quarter of 2022 alone, management allocated $20 million to buy back 364,320 shares. And from the third quarter of 2021 through the third quarter of 2022, the total number of shares for the business fell by nearly 1.55 million. Adjusting for all of this, we should expect, if management did not buy back any additional shares in the final quarter, net income of $49.6 million. That would represent an improvement over the $44.7 million reported one year earlier. That falls in at the low end of what management expects of between $49 million and $52 million.
What this all demonstrates is that the company is doing well to adjust to difficult market conditions. Although undoubtedly improvements in supply chain issues have helped the business, cost-cutting initiatives, combined with the firm’s ability to benefit from economies of scale as it grows, are all incredibly beneficial for shareholders. In the event that this trend continues, which is something we will get insight into when management announces guidance for 2023, the viability of the company from an investment perspective could change significantly. Consider the chart above, which shows how the company is valued using estimated results for 2022 as a whole. That same chart also shows the valuation of the business using data from 2021. At present, shares do look rather expensive. But a return to more normal levels of profitability would make the stock look more reasonable. As part of my analysis, I did also compare the company to five similar businesses. This assessment can be seen in the table below. If we use estimates for 2022, shares look to be near the high end of the spectrum relative to peers. But if we instead assume a return to levels of profitability seen in 2021, we would end up with a situation where the stock is cheaper than four of its five rivals on a price to adjusted operating cash flow basis while being around the middle of the pack on an EV to EBITDA basis.
Based on how performance was for the third quarter of 2022, and assuming that guidance provided by management is more or less accurate for the fourth quarter that the company is about to report on, I would say that the worst days for Ollie’s Bargain Outlet Holdings are behind it. The company had a rather rough spot that it had to contend with. But that picture looks over. Along the way, management has continued to focus on long-term growth initiatives, and it has continued to buy back stock as shares have fallen. Assuming that guidance for 2023 does not show the business backtracking from a profitability perspective, I do believe that a more appropriate rating for the business moving forward would be a ‘hold’ as opposed to the ‘sell’ I had it rated previously.