BIG LOTS INC BIG
July 16, 2011 - 11:02pm EST by
algonquin222
2011 2012
Price: 33.79 EPS $2.75 $0.00
Shares Out. (in M): 75 P/E 10.9x 0.0x
Market Cap (in $M): 2,540 P/FCF 9.1x 0.0x
Net Debt (in $M): -283 EBIT 353 0
TEV ($): 2,256 TEV/EBIT 6.3x 0.0x

Sign up for free guest access to view investment idea with a 45 days delay.

 

Description

Big Lots looks like a textbook public LBO. Management recently rejected a private equity buy-out offer for being too low and countered with a massive buyback authorization of their own which is equal to 18% of shares outstanding. The current management team has already bought back 45% of shares outstanding since they joined Big Lots in 2005.

Big Lots is debt free, trades at 9.1x free cash flow and 10.9x P/E. Earlier this year it was a hot stock and rumored to be a buyout candidate. A few months, a rejected deal, and one bad quarter later, it seems to be forgotten.

Big Lots is the largest close-out retailer in US. It was founded in 1967 and has 1,405 stores. If you have never been to a store - think Kmart type layout with lower prices and cleaner and more appealing stores. About half of Big Lot's merchandise is purchased from other vendors during liquidations, packaging over-runs, and discontinued product events. The other half is procured the "traditional way" - by ordering in advance from vendors in China. This is a similar business to the "dollar store" model except Big Lots has much larger stores (30k sq feet usually) and sells larger items like furniture in addition to the standard fare.

What I really like about the business is Big Lots appears to be one of the rare businesses that perform better during recessionary periods. There are two main reasons for this which you can probably guess: first, as a heavy discounter, it benefits from consumers trading down and looking for more value. Second, it is one of the vultures of the retail world - taking advantage of the stumbles of its retailing peers. The harder the retailing environment, the more stumbles and the more discounted merchandise Big Lots gets to sell. Big Lots' performance during 2008 and 2009 is a case study in this. Operating profit grew almost 8% in 2008 and 27% in 2009. In margin terms, operating profit was above 5% in each year. Sales were basically flat from 2007 to 2008 (down 0.2% despite closing 14 stores) and grew 1.8% from 2008 to 2009. Return on equity was solid both years at 17.1% and 21.9%, in 2008 and 2009 respectively.

This is a quality management team. When rents were rising, they closed stores and resisted the urge to grow, but when other retailers were closing stores and rents we falling, they began to expand the store base. Since 2005, when the current CEO joined, they have bought back 45% of the company at an average price of $24 ($1.2bln). Operating margins were 1.7% in 2005 and today are 7.2% which is attributable to fixing up the stores, cutting costs, and focusing more on branded products. Not surprisingly, Wall Street doesn't "get" them, but card carrying contrarians/value investors should. Here is an example from the 2008 Letter to Shareholders that I think says a lot about the management team:

Perhaps the best way to describe our real estate strategy is that we have moved counter to the market and most of retail. During the latter part of 2005 and early 2006, we closed a number of underperforming locations. We told our shareholders and the investment community that we would be slowing new store growth significantly. We source our real estate like we source our merchandise - always looking for great value - and at the time, real estate was not a value. Instead, we focused on improving our internal productivity and operations to more efficiently manage our existing stores.

Shortly after we made the decision to slow new store growth, a Wall Street analyst told me, "If you are waiting for real estate prices or rents to go down, you could be waiting for an awfully long time, or you may NEVER be a store growth story again." Despite his point of view, I was not about to use our shareholders' cash to chase overpriced real estate just to be a store growth story for the sake of the market. Instead, we focused on becoming a more productive and efficient operation, knowing that the real estate market would eventually come back. We understand what works for our strategy, and we understand the value of cash and how to put it to good use.

At the end of May 2011, Big Lots announced another large share buyback of $400mm. They have the cash, cash flow and credit line to fulfill it. If they do the full program, it would be equivalent to 18% of shares outstanding (including $57mm stub from previous authorization). Their other buyback programs have been completed so it is reasonable to think they will eventually complete this one as well.
At 10.9x earnings and 9.1x free cash flow, Big Lots seems unreasonably cheap given its quality balance sheet, management, growth opportunities and most importantly its reverse cyclical nature. You can own a company that will benefit from a double dip recession for under 10x free cash flow and is buying back stock at a rapid clip. Given the free cash flow into buybacks strategy, it is interesting to note that Eddie Lampert's ESL took a position in Big Lots in the first quarter.


Note: I am calculating P/E by subtracting cash from the market cap since they are likely to use it to buyback shares. I used the low end of their updated guidance of $2.75 per share as the denominator. The high end of the guidance was $2.90 and LTM EPS was $2.88.


Free cash flow is calculated by taking reduced guidance of $185mm "cash flow" for 2011. This number which was provided by management includes growth capex as well as maintenance capex so I added back full year management guidance capex of $125mm and then backed out share based compensation of $23.7mm (2010 level), and $40mm maintenance capex (from management). This totals $246.3mm 2011 free cash flow. This compares to LTM free cash flow of $269.3mm [Operating cash flow of $333mm and subtracting maintenance capex ($40mm) and share based compensation of $23.7mm.]

 


Big Lots looks cheap on an absolute basis. In addition, there seems to be a disconnect between the valuation of the "dollar stores" and Big Lots. The "dollar stores" which include Dollar Tree, 99 Cents Only, Dollar General and Family Dollar trade at an average LTM trailing P/E of 19 times. The "dollar stores" are growing faster and have higher margins, but the discount seems overdone. Big Lots is actually quite similar to Wal-Mart on valuation, margins, and ROE so fans of Wal-Mart may be interested in Big Lots as well. I think Big Lots may have more to offer as a stock though because of the larger buyback (18% for Big Lots vs 8% for Wal-Mart), hostile acquisition possibility, and arguably higher growth capacity.


Since the new CEO took over in 2005, revenue has grown by 19% total (not annualized). From 2005 to 2009 they were closing stores. However as commercial rents have fallen, they have been opening new stores at around a 3% growth clip. Several news articles have stated they are the number one new leasee of space (in terms of square footage) in the US. 3% growth isn't nothing, but its certainly nowhere close to what the "dollar stores" are doing. However, they just made an acquisition of the 91 store Liquidation World chain in Canada. Those stores are losing money on an EBITDA basis and Big Lots acquired it for basically just the assumption of its debt. Big Lots management stated that most people are underestimating the value this new acquisition could provide. It is hard to make any estimate, but what is clear is that Big Lots will be growing at a faster clip than they did prior to 2008 and may even surprise to the upside because of store growth and the Liquidation World acquisition. The good news is you aren't paying for any growth.

 

So why is Big Lots cheap? In the middle of May they announced earnings which surprised on the downside and lowered guidance for the rest of the year. This was followed by an announcement that they would not sell themselves after receiving bids from several private equity firms. News of a potential buyout had leaked in February and there was a lot of hot money in the stock that left when they announced there would be no deal in conjunction with the poor earnings. The reason there was no deal: Big Lots management thought the private equity bids were too low.

 


So add it all up and you have a business in and of itself has a margin of safety because it is counter cyclical, is trading at a cheap valuation, a quality management team that understands capital allocation and is plowing free cash into buybacks, and you might even get some unexpected growth. If the economy keeps improving, Big Lots should benefit from increased discretionary income, lowered unemployment and may even see its multiple rise. If we double dip, its cash flow should be protected because of the nature of the business and management looks set to continue to buy back huge amounts of stock.

 

 

Catalyst

Continued buybacks, potentially another buyout offer
    sort by    

    Description

    Big Lots looks like a textbook public LBO. Management recently rejected a private equity buy-out offer for being too low and countered with a massive buyback authorization of their own which is equal to 18% of shares outstanding. The current management team has already bought back 45% of shares outstanding since they joined Big Lots in 2005.

    Big Lots is debt free, trades at 9.1x free cash flow and 10.9x P/E. Earlier this year it was a hot stock and rumored to be a buyout candidate. A few months, a rejected deal, and one bad quarter later, it seems to be forgotten.

    Big Lots is the largest close-out retailer in US. It was founded in 1967 and has 1,405 stores. If you have never been to a store - think Kmart type layout with lower prices and cleaner and more appealing stores. About half of Big Lot's merchandise is purchased from other vendors during liquidations, packaging over-runs, and discontinued product events. The other half is procured the "traditional way" - by ordering in advance from vendors in China. This is a similar business to the "dollar store" model except Big Lots has much larger stores (30k sq feet usually) and sells larger items like furniture in addition to the standard fare.

    What I really like about the business is Big Lots appears to be one of the rare businesses that perform better during recessionary periods. There are two main reasons for this which you can probably guess: first, as a heavy discounter, it benefits from consumers trading down and looking for more value. Second, it is one of the vultures of the retail world - taking advantage of the stumbles of its retailing peers. The harder the retailing environment, the more stumbles and the more discounted merchandise Big Lots gets to sell. Big Lots' performance during 2008 and 2009 is a case study in this. Operating profit grew almost 8% in 2008 and 27% in 2009. In margin terms, operating profit was above 5% in each year. Sales were basically flat from 2007 to 2008 (down 0.2% despite closing 14 stores) and grew 1.8% from 2008 to 2009. Return on equity was solid both years at 17.1% and 21.9%, in 2008 and 2009 respectively.

    This is a quality management team. When rents were rising, they closed stores and resisted the urge to grow, but when other retailers were closing stores and rents we falling, they began to expand the store base. Since 2005, when the current CEO joined, they have bought back 45% of the company at an average price of $24 ($1.2bln). Operating margins were 1.7% in 2005 and today are 7.2% which is attributable to fixing up the stores, cutting costs, and focusing more on branded products. Not surprisingly, Wall Street doesn't "get" them, but card carrying contrarians/value investors should. Here is an example from the 2008 Letter to Shareholders that I think says a lot about the management team:

    Perhaps the best way to describe our real estate strategy is that we have moved counter to the market and most of retail. During the latter part of 2005 and early 2006, we closed a number of underperforming locations. We told our shareholders and the investment community that we would be slowing new store growth significantly. We source our real estate like we source our merchandise - always looking for great value - and at the time, real estate was not a value. Instead, we focused on improving our internal productivity and operations to more efficiently manage our existing stores.

    Shortly after we made the decision to slow new store growth, a Wall Street analyst told me, "If you are waiting for real estate prices or rents to go down, you could be waiting for an awfully long time, or you may NEVER be a store growth story again." Despite his point of view, I was not about to use our shareholders' cash to chase overpriced real estate just to be a store growth story for the sake of the market. Instead, we focused on becoming a more productive and efficient operation, knowing that the real estate market would eventually come back. We understand what works for our strategy, and we understand the value of cash and how to put it to good use.

    At the end of May 2011, Big Lots announced another large share buyback of $400mm. They have the cash, cash flow and credit line to fulfill it. If they do the full program, it would be equivalent to 18% of shares outstanding (including $57mm stub from previous authorization). Their other buyback programs have been completed so it is reasonable to think they will eventually complete this one as well.
    At 10.9x earnings and 9.1x free cash flow, Big Lots seems unreasonably cheap given its quality balance sheet, management, growth opportunities and most importantly its reverse cyclical nature. You can own a company that will benefit from a double dip recession for under 10x free cash flow and is buying back stock at a rapid clip. Given the free cash flow into buybacks strategy, it is interesting to note that Eddie Lampert's ESL took a position in Big Lots in the first quarter.


    Note: I am calculating P/E by subtracting cash from the market cap since they are likely to use it to buyback shares. I used the low end of their updated guidance of $2.75 per share as the denominator. The high end of the guidance was $2.90 and LTM EPS was $2.88.


    Free cash flow is calculated by taking reduced guidance of $185mm "cash flow" for 2011. This number which was provided by management includes growth capex as well as maintenance capex so I added back full year management guidance capex of $125mm and then backed out share based compensation of $23.7mm (2010 level), and $40mm maintenance capex (from management). This totals $246.3mm 2011 free cash flow. This compares to LTM free cash flow of $269.3mm [Operating cash flow of $333mm and subtracting maintenance capex ($40mm) and share based compensation of $23.7mm.]

     


    Big Lots looks cheap on an absolute basis. In addition, there seems to be a disconnect between the valuation of the "dollar stores" and Big Lots. The "dollar stores" which include Dollar Tree, 99 Cents Only, Dollar General and Family Dollar trade at an average LTM trailing P/E of 19 times. The "dollar stores" are growing faster and have higher margins, but the discount seems overdone. Big Lots is actually quite similar to Wal-Mart on valuation, margins, and ROE so fans of Wal-Mart may be interested in Big Lots as well. I think Big Lots may have more to offer as a stock though because of the larger buyback (18% for Big Lots vs 8% for Wal-Mart), hostile acquisition possibility, and arguably higher growth capacity.


    Since the new CEO took over in 2005, revenue has grown by 19% total (not annualized). From 2005 to 2009 they were closing stores. However as commercial rents have fallen, they have been opening new stores at around a 3% growth clip. Several news articles have stated they are the number one new leasee of space (in terms of square footage) in the US. 3% growth isn't nothing, but its certainly nowhere close to what the "dollar stores" are doing. However, they just made an acquisition of the 91 store Liquidation World chain in Canada. Those stores are losing money on an EBITDA basis and Big Lots acquired it for basically just the assumption of its debt. Big Lots management stated that most people are underestimating the value this new acquisition could provide. It is hard to make any estimate, but what is clear is that Big Lots will be growing at a faster clip than they did prior to 2008 and may even surprise to the upside because of store growth and the Liquidation World acquisition. The good news is you aren't paying for any growth.

     

    So why is Big Lots cheap? In the middle of May they announced earnings which surprised on the downside and lowered guidance for the rest of the year. This was followed by an announcement that they would not sell themselves after receiving bids from several private equity firms. News of a potential buyout had leaked in February and there was a lot of hot money in the stock that left when they announced there would be no deal in conjunction with the poor earnings. The reason there was no deal: Big Lots management thought the private equity bids were too low.

     


    So add it all up and you have a business in and of itself has a margin of safety because it is counter cyclical, is trading at a cheap valuation, a quality management team that understands capital allocation and is plowing free cash into buybacks, and you might even get some unexpected growth. If the economy keeps improving, Big Lots should benefit from increased discretionary income, lowered unemployment and may even see its multiple rise. If we double dip, its cash flow should be protected because of the nature of the business and management looks set to continue to buy back huge amounts of stock.

     

     

    Catalyst

    Continued buybacks, potentially another buyout offer

    Messages


    SubjectViews on MGMT
    Entry07/17/2011 05:29 PM
    Membergary9
    Hi.  In your write-up, you paint the management team very favorably.  I want to ask you about this.  I agree that they have done a nice job getting margins higher and being prudent in capex.  
     
    However, I believe they spent $148m on share buybacks in 06, $712.5m on buybacks in '07, and spent $37.5m on share buybacks in '08.  But, if I recall correctly, management sold more than 1m shares in '07 and 1m shares in '06.  I find it a little unsettling that they would simultaneously spend shareholder capitl on buying back the stock, while unloading the stock from their personal accounts.  What do you think about this?  
     
    Thanks.  
     

    Subject"...one bad quarter later, ..."
    Entry07/18/2011 04:39 AM
    Memberwan161
    Hi, Can you talk more about the bad quarter?  How bad was it?  Why was it bad?  Why won't it be repeated?  you mentioned it in passing but didn't cover it again.  More insight would be helpful. Thanks.

    SubjectRE: Views on MGMT
    Entry07/18/2011 11:20 AM
    Memberalgonquin222
    Gary,
    I am as big of a believer in insider buying as it gets and I agree that its not ideal to see some insider selling here. Although if you look deeper most of the sales are either shares withheld to pay for taxes regarding restricted stock grants or planned option excercisement sales. There have been some open market dispositions though.
    Insiders still own $38mm worth of stock so they clearly are incentivized to get the stock price up, but its not like they own 40% of the company so its definitely a concern.
    I'm guessing (and I have not spoken with management about this) that they feel they need to diversify their portfolio rather than bet so big on their company to the tune that both their livelihood and portfolio rest on the same performance of the same company. I've ran into these issues before where whole companies use the same financial advisors who scare them into diversifying.
    They aren't dumb and realize that the stock buybacks they have made have appreciated by 40% on average while their personal sales probably haven't done as well (unless they were buying private facebook stock with the proceeds...)

    SubjectRE: big lots
    Entry07/18/2011 11:41 AM
    Memberalgonquin222
    BIG comp'd down in 2009 during one of those recessionary periods, so I don't think your contention that the business does well during a down period is supported by history, at least recent history
    It comp'd down in the first three quarters of 2009 (vs first 3 quarters of 2008) and then comp'd up big (+5.1%) on Q4 (seasonally strong quarter). I don't think that invalidates the fact that for the full year and for 2008 they kept sales and margins while other retailers were getting crushed.
    *I think the reason the dollar stores, particularly Dollar Tree, have done so consistently well with comps (which explains the valuation differences) while BIG has not is because DLTR really is getting trade down customers and BIG has not.  I say this based on shopping experiences - BIG as a store has a lot of issues with presentation, mix (furniture is a big component of sales, as if auto parts, toys, etc), technology, etc.  It can be a grimy, dirty place, and isn't going to attract a middle income customer even if the value are there (and by the way, they do have values). Plus, the store itself is a lot larger than a FDO or DG which serve as min-WMTs in effect.  BIG itself knows this, and it trying to move some stores to better locations.  We'll see - one I've been to in a newer spot looks a lot better, but these are still a small part of the fleet, but getting middle income customers into the store has to be one of management's main priorities.
    I've been to a few stores and thought they were pretty clean and a good experience. They have been refurbishing their store base so its possible, I hit updated ones. They have  been moving into what they call "A" store locations. They are taking advantage of lower rents to get more prime locations to take advantage of these trade down customers. I would be considered a trade down customer and went into on a road trip (I'd never even seen a Big Lots store before). I loved the treasure hunt aspect and bought a bunch of stuff I didn't need or have any desire for before walking into the store. I think the value is there for the trade down customers, but they need to get the stores in the right locations. Its going to take awhile though as they are only opening these new "A" stores at an slow clip.  I think the difference with the dollar stores is at their multiples you are paying for that growth to continue while at BIG, you aren't really.  
    *minor comment, but I don't think management handles there buybacks all that well.  In fact, when you've seen them do a buyback, that's often time for comps to slow and business to dip a little.  They weren't aggressive with the buyback in the midst of the great recession either. If it matters, BIG just did a 20% sale for the entire ticket (for BUZZ Club members) this weekend.  As a friend joked, the last time they did that the rumors of an LBO occurred.
    Interesting. I'm really focused on the next 3-5 years so if they continue to generate free cash flow, buyback stock, operate well and grow slowly, the stock should perform nicely. You may be right that there will be a better entry point if this quarter isn't shaping up well.
    Hey, if you don't mind, where exactly did BIG acknowledge a private equity bid? 
    From the article below. WSJ cites people familiar with the matter so BIG never actually acknowledged it. However, I don't think the WSJ would run the story without solid confirmation.
    http://online.wsj.com/article/SB10001424052748703482104576331950661112630.html?mod=googlenews_wsj

    SubjectRE: RE: RE: big lots
    Entry07/18/2011 07:52 PM
    Memberalgonquin222
    I think you definitely have something to be upset about, but it may not be Reg FD violation since it was widely dispersed rather than to just one individual. My guess is the source was someone on the PE side...
     I am not as worried as you about the business getting that hit during another recession. We just went through a very bad one and they made it through really well - growing operating profits both years. Don't forget that they get an extra boost from all the extra brand name merchandise they are able to sell from the other retailers. They haven't said it publicly as far as I can tell but I am pretty sure that the closeout items have better margins. So even if they lose some customers, their margins get a boost from the extra close-out items.
    I also think that we learned that Americans will keep buying "stuff" no matter how bad things get. 08 happened and in aggregate, people still bought  non disretionary items - not as much and not as rapidly but they still bought. As the cheapest provider, BIG should still get their sales.  
    I agree, if BIG figures out how to get more trade downs they are in really good shape. Management seems to get this too based on their new store openings, but its definitely going to be slow.
    Thanks for the insight on the store base.

    SubjectRE: Still following?
    Entry04/24/2012 06:19 PM
    Memberalgonquin222
    I apologize, but I haven't been following this situation recently.
      Back to top