BIG LOTS INC BIG
September 11, 2012 - 10:42am EST by
murman
2012 2013
Price: 30.44 EPS $3.25 $3.80
Shares Out. (in M): 60 P/E 9.2x 7.8x
Market Cap (in $M): 1,820 P/FCF 9.0x 7.8x
Net Debt (in $M): 128 EBIT 345 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Retail
 

Description

This write-up is not intended as a standalone analysis.  BIG has been written-up on VIC three times.  The intent here is to provide color on the recent BIG fundamental underperformance and make a case that despite recent disappointments (and because of significant stock decline) BIG is an attractive investment.     

Two significant differences vs dollar stores: 

 

  1. Consumables are 30% of its sales, dollar stores consumables are 60%
  2. Half of its total merchandise and 70% of consumables are closeouts which are predictable in the short run

 

These two difference are responsible for the higher volatility of BIG's same store sales.  At the same time closeouts make BIG a unique retailer with no direct competitors.  About 15% of BIG's sales is seasonal merchandise which is bought directly from factories (not closeouts).  BIG buys it once for the season.  (In Q2 it seasonal merchandising was subpar, all good stuff sold out fast and the rest, less 3.good merchandise, had to be discounted).  Seasonal business could be a very good business but offers plenty of same store sales risk - weather impacts that business significantly, also merchandising screw ups (as happened in Q2 2012) make this business more volatile. 

 

In 2011 BIG bought a closeout retailer, Liquidators, out of bankruptcy, the idea was it is a cheap way to get into Canada at scale.  It is a significant turnaround, this Canadian business lost money for six years, the goal is for Canadian stores to reach break-even by Q3 2012 (so far it appears that it will achieve that goal).   In Q2 2012 BIG increased inventory and assortment in Canadian business, increase was intentional because stores lacked inventory.  

 

Inventories are up 13% for several reasons:  

  1. Store count  increase - good reason
  2. Increase in consumables in existing stores (they received more branded merchandise) - not worried (at least not yet).  Management says  increased consumables inventories level is not indicative of future higher inventories
  3. Fireplaces - intentional seasonal build up  - not worried
  4. Furniture - this is bad, it was driven by bad merchandising

 
Q2 2012 screw up

  

  • Sales are up 1.7%, but same store sales are down 1.9% (total sales increase is driven by opening new stores)
  • In previous quarter BIG struggled with merchandising in electronics and consumables, they fixed it in Q2.
  • Sales weakness was driven by two categories: seasonal and furniture - completely driven by bad merchandising.  These businesses are not closeouts (for the most part), merchandise is purchased from factories directly.  
  • COGS were up slightly to 60.8%, higher than annual average of 60% in 2011 and 59.4% in 2012
  • SG&A expense as % of revenue was up a LOT - 33.8%, annual averages 2012 and 2011 are 31.6% and 31.8%.  In Q1 2012 this number was up as well, it was 32.3% - this is driven by sales de-leveraging.  BIG needs same store sales to go up for it to maintain its margins.   Per my conversation with management, there are no costs left to be cut at the store level (they are very efficient there already).   Management  is insistent that there are still costs left to be cut on the corporate, but I am not really sure where.  In 2012 BIG installed SAP's inventory and financial management software, in theory it should make them more efficient, Steve Fishman (CEO) usually doesn't commit capital to anything unless it meets his IRR. 
  • Margins will be impacted further in Q3, possibly in Q4 by clearing inventory in furniture and seasonal (seasonal inventory is cleared faster and thus will impact mostly Q3). 
  • Deficiencies in the quarter came from merchandising, the merchandising guy that was on the job for a little bit more than a year was fired.  Steve Fishman brought back John Martin who was in charge of merchandising from 2003 to 2011 and was very good at it.  In 2011 he was promoted to a more administrative, human resources and operations role.  John Martin will likely be able to right the ship; it doesn't seem that the problem here is structural.  However, this quarter highlighted an Achilles heel in BIG - merchandising, the business requires a constant merchandising touch.  We don't like that one person can really make such a significant difference in company's business on day to day basis.  BIG probably deserves a lower multiple than we previously thought.   

There are several ways to improve merchandising:

  • Remember there are two distinct categories we are addressing here: closeouts and non-closeouts.  
  • Closeouts - BIG needs (and it will) to broaden and deepen its relationship with manufacturers.  This is important because it will improve its assortment and will give a better lead time into what merchandise it will have. 
  • On a non-close out front - it simply needs better merchandising; it needs to entice people to come into its stores. 

Coolers and freezers 

Steve Fishman mentioned that BIG will be experimenting with bringing coolers and freezers into its stores.   BIG needs to bring coolers and freezers so it can sell perishable items which will hurt its margins, but will help them on two fronts: first, will increase frequency of store visits and second will allow BIG to take food stamps (which are now called SNAP transactions).  Steve Fishman was against this for a long time, but things have changed.  Now a significantly larger portion of the population uses food stamps and company's registers are now able to take food stamps.  However, this is an experiment, BIG will try it out in five areas at first.  We don't know what capex will be if it decides to go with it.  


Balance sheet

Historically BIG was fairly debt averse, but this quarter its debt has increased to $240mm with around $50mm of cash.  BIG bought back $149mm stock in the quarter.  Company expects to exit the year with $140-150mm of debt on the credit line (did not indicate cash position).  Its cash flows for the year will be about $70mm lower than it expected going into second quarter.  

BIG has two methods of buying back stock, normal purchase which gives BIG roughly two week window during the quarter and 10 B5-1 plan – BIG tells broker to buy so many shares at certain price and there is nothing it can do afterwards.  So even as business deteriorated it could not put a stop on share repurchases.  Even though it has $50mm share buyback I suspect BIG will stop buying back stock for at least a few quarters until it pays off its line of credit (S&P possible downgrade is another motivator why BIG will do that).  

 

Guidance for 2012

  

  • EPS 2.80-2.95, down from 3.25-3.45, $2.99 in 2011.  EPS in 2012 is benefited by 10% stock repurchase and but hurt by full year of ownership of Canadian business (vs. owning it 6 months last year).  It will have a loss of 0.22-0.26 share. 
  • Same store sales decrease in low single digits, total 3-4% driven by US stores
  • Gross margins US - gross margin low because of markdowns and mix
  • Depreciation is impacting margins because of new store openings (but this is not the core reason for bad results.) 

 

Bottom line

 

  • Is BIG structurally, fundamentally broken?   All wounds in Q1 and Q2 were self-inflicted by BIG not its competitors (and not Amazon).  It has a fairly unique business model and a competitive advantage.   Its currents problems are fixable.  Management has already made correct moves to fix them, but bad merchandising decisions take a few quarters (and lower margins) to fix.  I believe BIG has a first rate management that is capable, rational and honest.  
  • What is its earnings power? Has its EPS been permanently impaired?  Next year's earnings are not linked to this year's reset number; once inventory is liquidated at lower margins new inventory (assuming merchandising is fixed) will have better margins.  Customer goodwill has not been damaged; just customers were not given good shopping choices (at the margin).  
  • Is there more downside fundamental risk?  BIG is trading at about 10x lowered 2012 guidance.  If its operating margins revert to 6.5% (they were 6.6% in 2011, 7.2% in 2010, 6.9% in 2009), opens 4% of new stores and has flat sales then EPS will be $3.77 with 1% same store sales $3.82.  You put a P/E of 12 it is a $45 stock. 

 

 

 

Catalyst

 
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    Description

    This write-up is not intended as a standalone analysis.  BIG has been written-up on VIC three times.  The intent here is to provide color on the recent BIG fundamental underperformance and make a case that despite recent disappointments (and because of significant stock decline) BIG is an attractive investment.     

    Two significant differences vs dollar stores: 

     

    1. Consumables are 30% of its sales, dollar stores consumables are 60%
    2. Half of its total merchandise and 70% of consumables are closeouts which are predictable in the short run

     

    These two difference are responsible for the higher volatility of BIG's same store sales.  At the same time closeouts make BIG a unique retailer with no direct competitors.  About 15% of BIG's sales is seasonal merchandise which is bought directly from factories (not closeouts).  BIG buys it once for the season.  (In Q2 it seasonal merchandising was subpar, all good stuff sold out fast and the rest, less 3.good merchandise, had to be discounted).  Seasonal business could be a very good business but offers plenty of same store sales risk - weather impacts that business significantly, also merchandising screw ups (as happened in Q2 2012) make this business more volatile. 

     

    In 2011 BIG bought a closeout retailer, Liquidators, out of bankruptcy, the idea was it is a cheap way to get into Canada at scale.  It is a significant turnaround, this Canadian business lost money for six years, the goal is for Canadian stores to reach break-even by Q3 2012 (so far it appears that it will achieve that goal).   In Q2 2012 BIG increased inventory and assortment in Canadian business, increase was intentional because stores lacked inventory.  

     

    Inventories are up 13% for several reasons:  

    1. Store count  increase - good reason
    2. Increase in consumables in existing stores (they received more branded merchandise) - not worried (at least not yet).  Management says  increased consumables inventories level is not indicative of future higher inventories
    3. Fireplaces - intentional seasonal build up  - not worried
    4. Furniture - this is bad, it was driven by bad merchandising

     
    Q2 2012 screw up

      

    There are several ways to improve merchandising:

    Coolers and freezers 

    Steve Fishman mentioned that BIG will be experimenting with bringing coolers and freezers into its stores.   BIG needs to bring coolers and freezers so it can sell perishable items which will hurt its margins, but will help them on two fronts: first, will increase frequency of store visits and second will allow BIG to take food stamps (which are now called SNAP transactions).  Steve Fishman was against this for a long time, but things have changed.  Now a significantly larger portion of the population uses food stamps and company's registers are now able to take food stamps.  However, this is an experiment, BIG will try it out in five areas at first.  We don't know what capex will be if it decides to go with it.  


    Balance sheet

    Historically BIG was fairly debt averse, but this quarter its debt has increased to $240mm with around $50mm of cash.  BIG bought back $149mm stock in the quarter.  Company expects to exit the year with $140-150mm of debt on the credit line (did not indicate cash position).  Its cash flows for the year will be about $70mm lower than it expected going into second quarter.  

    BIG has two methods of buying back stock, normal purchase which gives BIG roughly two week window during the quarter and 10 B5-1 plan – BIG tells broker to buy so many shares at certain price and there is nothing it can do afterwards.  So even as business deteriorated it could not put a stop on share repurchases.  Even though it has $50mm share buyback I suspect BIG will stop buying back stock for at least a few quarters until it pays off its line of credit (S&P possible downgrade is another motivator why BIG will do that).  

     

    Guidance for 2012

      

     

    Bottom line

     

     

     

     

    Catalyst

     

    Messages


    SubjectIssues
    Entry09/11/2012 03:18 PM
    Membercnm3d
    How do you get comfortable with how little control they have over their inventory? What makes you comfortable with 4% square footage growth? Why is it worth $45 today when PE wouldn't buy it there and then BIG horribly missed guidance, mainly because they don't control inventory and have little way to predict sales?
     
    Thanks.

    SubjectRE: Issues
    Entry09/11/2012 07:24 PM
    Membermurman
    They have control over direct purchases, however, and you are right, they don't have control over closeouts.  Customers that come to their store don't expect consistency of merchandise but they do expect value.   Their same store sales will not have consistency of DG or FDO, but if well managed same store sales should go up.   BIG generates significant cash flows and plans and can afford to open 4% new stores a year.  

    Subjecttypos
    Entry09/12/2012 01:31 PM
    MemberSpocksBrainX
    pls read thru them = wish this place had an edit feature

    Subjectexactly what is the recommendation here?
    Entry10/01/2012 11:09 AM
    Membertyler939
    You say the write-up is not intended as a standalone analysis.  Are you suggesting a pair trade where you go long Big and short DG and FDO (or some other name)?  If so, would you mind commenting on the short side of this trade?  Thanks.

    SubjectRE: Big LOTs print
    Entry05/30/2013 08:52 AM
    Membercnm3d
    I'm not sure how BIG is going to turn this around. They are rolling out consumables... but the whole BIG strategy is to take really crappy real estate cheap and drive traffic with the unique business model. So how are they going to drive consumables traffic to lousy locations when there is a dollar store, discount store, or grocery store every 35 feet in America? Second, what exactly is that upsell model? Come for the frozen pizza, but get a grill and portable DVD player as well?
     
    Trouble is it is "cheap"...

    SubjectRE: RE: Big LOTs print
    Entry06/17/2013 02:05 PM
    Membercnk123
    I am struggling a little with how to conceptualize the opportunity right now (or lack of opportunity). It certainly looks "cheap" at ~7x LTM EBIT with a reasonable FCF yield - if you don't believe the business gets any worse, which seems to be the issue.
     
    What are people's thoughts on relative valuation for this business - i.e. what multiple should a close out retailer without much control of their non-consumable merchandise and what seems like muted long term unit growth (relative to dollar store competitors, etc) trade at relative to higher multiple off price and dollar store comparables?
     
    The visibility to SSS seems to be an issue here - the business is highly sensitive to merchandising mix given the implied volatility which presumably is an issue in pricing a PE LBO case as well.  Lastly on this, as CNM3D commented, driving traffic via consumables to drive bigger ticket furniture/seasonal/home purchases doesn't hang together for me but I'm happy to hear where I am wrong on that.
     
    If its true that most of the cost structure rationalization at the unit level is now complete and remaining leverage comes from SSS growth that is interesting in the sense that EBIT margins (on a full year basis) are now back to around 2008 levels.  Given the growth in revenues and degradation in EBIT margins, you'd think there were costs, whether at the corporate or store level that could be rationalized. 
     
    Lastly, the unit economics, just from scanning and adjusting the system level numbers seem ok - there seems to be a reason for this business to exist I just struggle with how you price the volatility in SSS given what seems like quarter by quarter pressure to ensure you have your merchandise mix right.  I can buy into the more consumables and freezer space to provide base revenue stability but with all of the competition out there are there true 'revenue synergies'? 
     
    It is enticing to normalize EBIT margins at 6.5% and assume nominal growth which drives >$40/share without the benefit of additional share repurchases in the interim, don't know if this is realistic though....
     
    A lot of questions for discussion, I don't really have an answer but it seems like there is something to do here though I can convince myself to stay away until they miss another quarter or revise guidance downward.
     
    Any thoughts would be appreciated.
     
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