Big Lots, Inc. $BIG
My Investment Checklist
1. Is the company undervalued?
EV/EBIT: 16.92 (Please note this excludes operating lease liabilities)
Big Lots trades at an absurd ratio relative to sales, however the company just posted arguably its worst quarter ever. Same store sales were down 17% YOY, inventories increased 48.5% compared to last year, and they lost $11.1M after guiding for a $32.5M profit. This has investors worried that the business model may be broken. Conversely optimists would argue that $BIG is suffering from macro-economic shocks that will subside in due time. If earnings do normalize the stock is no doubt woefully mispriced. There’s certainly some hair on this investment, but where there’s uncertainty there’s also opportunity!
2. Can I easily explain what the company does?
Yes, they’re a discount retailer who sell home goods. Roughly 75% of sales are discretionary ie; furniture and 25% are consumer staples ie; food.
3. Does the cash flow statement line up with income statement?
No, the income statement doesn’t even come close to matching the cashflow statement:
This is a big time red flag, although inventories have nearly doubled since August of 2020. When you account for working capital these numbers begin to make more sense.
Regarding capital allocation $BIG spent most of their money on share repurchases, inventories, capital expenditures and debt repayment. I’m most concerned with the inventory buildup, as it implies management doesn’t fully understand their customer’s wants or were they’re at in the business cycle. Additionally share repurchases put $BIG in a precarious liquidity position. They only have $61.7M in cash on the balance sheet with over $1B in current liabilities. I’m all for rewarding shareholders, but surviving should always be the first priority.
4. Is the Balance Sheet Healthy?
Total Cash: $61.7M
Total Debt: $1.27B
Current Ratio: 1.52
It’s important to note that I’m calculating total debt as current liabilities + long term debt. At face value the balance sheet looks extremely problematic, however long term debt is only sitting at $270M. Furthermore net interest expenses are projected to be ~$11M for the entire year. The bad news is that Big Lots is expected to lose money in the following two quarters and have next to no cash available. On the other hand with inventories so high, $BIG expects to print $100M in FCF next quarter. This should buy Big Lots some time, but if the business isn’t turned around by 2023 they’ll likely have to tap capital markets to rejigger their debt.
5. How profitable is the business?
Gross Margins: 38.1%
Operating Margins: 1.9%
Net Margins: 1.2%
As you can $BIG has had a tough go of it lately, but the company does have some potential if they can right the ship:
I’m not gonna sit here and pretend $BIG is a good business, but margins are likely nearing a bottom. Management has also implemented “Operation North Star” (such a douchey name btw) were they plan on hitting $8-$10B in sales with a 6-8% EBIT margin. I’m skeptical they come anywhere close to an 8% operating margin, as 6.4% was the best they posted in the last decade. Although I don’t think it’s unrealistic to forecast 5% EBIT margins as normalized, especially considering that gross margins have been around 40% historically.
6. What is the company’s growth potential?
10-yr Revenue CAGR: 1.8%
10-yr Operating Profit CAGR: (2.59%)
10-yr FCF CAGR: (13.85%)
Last year was suboptimal for $BIG, which is painting an overly pessimistic picture. Although even if we use 2021 as an end date, EBIT only grew at a 2.6% annually from 2013. Suffice to say investors aren’t in this name for its growth prospects. Be that as it may $BIG still has some runaway left to open new stores, particularly on the west coast. Moreover same store sales have increased by ~1.5% annually over the last 10 years. For these reasons I don’t think $BIG is a melting ice cube, and low single digit growth seems more than attainable.
7. Is management rewarding shareholders?
Big Lots offers investors a 4.9% dividend and have $159M remaining on their share repurchase program. With that said management has implied they’re not going to buyback shares until they get back to profitability. I think this is prudent but if it was up to me, I would cut the dividend and use that capital for buybacks instead. Big Lots was repurchasing shares at over a $2B market cap last year, but put themselves in a position where they can’t buyback shares at a $650M market cap!!! When you consider that $BIG printed over $264M in FCF in 2021, it’s remarkable that the CFO still has job. That’s a colossal fuck up and inexcusable IMO. Additionally SBC was $39.6M last year, so shareholders are effectively getting a 0% net yield (0.3% to be exact)!
8. How does the company stack up against their peers?
Big Lots closest competitor is Ollie’s Bargain Outlets $OLLI:
$OLLI Price/Sales: 1.64
Operating Margins: 11.6%
In full disclosure Ollie’s makes up ~7% of PA, so this is going to be biased. However $BIG is significantly cheaper on a sales basis. Conversely $OLLI is returning more capital back to shareholders, has a better balance sheet, and much superior growth prospects. Additionally Ollie’s SG&A spend is meaningfully lower than Big Lot’s. For example SG&A is about 25% of sales for $OLLI, while $BIG comes in at ~33%. This is likely because Ollie’s doesn’t have an ecommerce offering or spend much on advertising. Whereas $BIG spends roughly $100M annually for advertising/brand ambassadors. As noted previously growth has been abysmal, so I don’t know why $BIG keeps doubling down on their advertising strategy. Being that I own $OLLI, I obviously think it’s a more attractive bet.
9. What’s the counter argument?
The counter argument is that Big Lot’s business model is broken and they will continue hemorrhaging cash.
I would partially disagree with this, while $BIG is a discount retailer most of the items they sell are discretionary. Additionally their problem doesn’t seem to be idiosyncratic, for instance Target and Macy’s stated recently that furniture and appliances saw a signific drop off in demand. Eventually discretionary items will come back into favor and $BIG will probably be a beneficiary when that happens. However there’s no doubt some fat to trim. Big Lots spending and capital allocation decisions have objectively destroyed shareholder value. Additionally the product mix doesn’t make any sense to me. They’re targeting a cost conscious customers, but selling them primarily high ticket items?!?!? I would prefer to see management getting back to basics, selling everyday items at a reasonable price and cutting the BS expenses!
10. Is there something I think the market may be missing?
Given the current valuation Mr. Market seems to think there’s a decent chance $BIG turns into a doughnut. I actually think the solvency concerns are overstated. For one Big Lots has a ridiculous amount of inventory, which even if marked down drastically should convert to substantial free cash flow. Moreover $BIG could do away with growth CAPEX spending and reduce SG&A if push came to shove. Because of this, I think $BIG weathers the storm near term.
Big lots is a tricky investment to think thru, given the wide range of possible outcomes. However my base case would be; 2% revenue growth for 5 years, a 5% EBIT margin at the end of 5 years, a 2% net shareholder yield per year, with a 8X EV/EBIT exit multiple at the end of year 5. This only works out to a ~10% expected return per year, which is what you can get by buying an index fund. Although it’s probably worth tracking as the assumptions I made are conservative. Moreover if the business gets back to profitably sooner than expected, share repurchases could do significant damage at this valuation.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice