We believe that Ollie’s Bargain Outlet Holdings stock (NASDAQ: OLLI) and Dollar General stock (NYSE: DG) are currently better valued than Costco stock (NASDAQ: COST). Costco’s current price-to-operating income ratio of 33x is higher than levels of 18x for OLLI and 15x for DG. But does this gap in valuation make sense? We don’t think so, especially if we look at the fundamentals of these companies. More specifically, we arrive at our conclusion by looking at historical trends in revenues and operating income for these companies. Our dashboard Better Bet Than COST: Pay Less To Get More From OLLI, DG has more details – parts of which are summarized below.
1. Revenue Growth
Costco’s Revenue grew at an average rate of 12% over the last two years, as compared to Ollie’s Bargain Revenue growth of 19% and Dollar General’s Revenue growth of 13%. All the three companies’ models positioned them to meet the increased demand for budget-conscious consumers – undoubtedly benefiting from the Covid-19 stimulus.
- Dollar General is the largest small format retailer in the U.S. In Q2, the company saw tough comparisons with the previous year, which gained from pandemic-led demand. The discount retailer saw same-store sales decline 4.7% year-over-year (y-o-y) in Q2 but grew 14.1% on a two-year basis. In addition, the company’s adjusted earnings per share (EPS) of $2.69 was down from $3.12 in the second quarter of fiscal 2020 but higher than $1.74 in the pre-pandemic quarter of 2019. It should be noted that the company still raised its fiscal 2021 guidance in its Q2 report. While higher supply chain costs due to transit and port delays and increased labor costs are expected to put pressure on the company’s margins over the short term, the company’s solid track record, an expanded customer base during the pandemic, and continued expansion should boost its profitability in the long-term.
- Ollie’s Bargain Outlet Holdings is a discount retail chain selling both staples and discretionary items (toys, home goods, electronics, hardware). The company seeks out excess inventory from suppliers to be sold at a substantially discounted price in warehouse-like stores. It specifically targets brand-name merchandise while purchasing the inventory. In the fiscal second quarter (ended July 31), comparable store sales decreased 28.0% from the prior year’s extraordinary 43.3%, but resulted in a two-year stack of positive 15.3%.
- Costco is a warehouse club operator. The company collects fees from its members and sells items in bulk at rock-bottom prices while making most of its operating margin from these membership fees. The company’s revenues grew a strong 17% year-over-year (y-o-y) to $63 billion, driven by comparable sales growth of 15.5% (excluding the impact of gas and F/X). In fact, the most striking takeaway from this report was a sequential increase of 0.3 percentage points in its member renewal rate from Q3 2021. The company’s member renewal rate stood at 90.3% in the core U.S. market and 88.7% worldwide.
2. Operating Income Growth
The two-year average operating income growth for Costco stood at 14%, much lower than 29% for Ollie’s and 23% for DG. Better revenue growth for the latter led to higher operating income. However, looking at the last twelve-month period, Costco’s growth in operating income was higher than its peers. We do not account for LTM growth in choosing these bets because of the skew introduced by Covid and the focus on long-term sustainable performance. We have also compared Costco’s metrics to that of OLLI and DG exactly a year ago – as shown below. A persistent underperformance in revenue and operating income growth (LTM) for COST likely reinforces the conclusion that the stock is expensive compared to its peers.
The Net of It All
Ollie’s Bargain Outlet Holdings and Dollar General have seen higher growth in revenues and operating income than Costco in the last two years. Yet, it appears to be cheaper than Costco. Despite better profit and revenue growth, OLLI and DG have a comparatively lower price-to-operating income ratio. We think this gap in valuation will eventually narrow over time to favor the less expensive name, Ollie’s Bargain Outlet Holdings and Dollar General.
COST Stock Comparison With Peers shows how it compares against other peers on metrics that matter.
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