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Robert Abbott
Robert Abbott
Articles (899)  | Author's Website |

Big Lots' Transformation

This retailer used a new strategy and its omnichannel capabilities to rapidly increase same-store sales

Investors looking for quality retail stocks selling for bargain prices don't have an abundance of choices.

One possible opportunity, in my opinion, is Big Lots Inc (NYSE:BIG). The discount retailer, which owns a chain of 1,411 stores as of the end of its fiscal third quarter (which ended on Oct. 31), describes itself as follows in its 10-K for 2019:

"We manage our business on the basis of one segment: discount retailing. We evaluate and report overall sales and merchandise performance based on the following key merchandising categories: Furniture, Seasonal, Soft Home, Food, Consumables, Hard Home, and Electronics, Toys, & Accessories."

One notable aspect of Big Lots' story was the way it bounced back after the March plunge, as shown in this 10-year chart:

Big Lots 10 year price chart

Note that the rebound, from $12.08 to $53.87, delivered a more than fourfold gain for investors who bought at the bottom. Since it topped out, the price retreated 16% to close at $45.06 on Dec. 11.

Although it has proven to be a profitable investment recently, can Big Lots continue to out-perform in the long term, say five to 10 years in the future? I think there are several reasons to think it can.

Of its current store locations, 33% are in just four states (California, Texas, Florida and Ohio). That means it has room to add more stores in most of the country.

One other question to ask is, will it have the financial resources to grow? Three key metrics suggest it will. Its three-year average growth rates are 6.2% for revenue, 14.1% for Ebitda and 22.9% for earnings per share without non-recurring items. In other words, this is a profitable company, and those profits can be used to fund some or all of its growth.

This brings us free cash flow, the money available to fund expansion (as well as dividends). Its free cash flow record is not great, and it has raised significant amounts of debt over the past few years:

Big Lots free cash flow and long-term debt

That debt looks serious on the chart, but the interest coverage ratio is still strong at 33.38; in other words, it has enough operating income to pay its interest expenses more than 33 times over.

Big Lots has used its borrowed and shareholder capital well - as shown in this chart, it has usually achieved a higher return on invested capital (ROIC) than it has paid for those earnings as measured by the weighted average cost of capital (WACC):

Big Lots ROIC vs WACC chart

It needs results like these to survive in a field that contains some of the toughest competitors, a list that includes Walmart (NYSE:WMT), Dollar General (NYSE:DG), Costco (NASDAQ:COST), Target (NYSE:T) and Home Depot (NYSE:HD).

Despite the competition, it shows respectable margins; the operating margin is currently 6.4% and the net margin is 10.3%. Its net margin is ranked higher than 93.81% of its competitors and peers in the retail – defensive industry.

Big Lots also makes it clear that growth is its priority. The one and only headline on the investors' page of its website is "Positioned to grow." It follows up with this statement:

"As a unique, non-traditional, discount retailer, our goal is to build upon this leadership position by expanding our market presence. Our strength in merchandising, purchasing, site selection, distribution, and cost-containment have positioned us for continued expansion and profitable growth for our shareholders."

Behind that promise is an initiative called "Operation North Star." Big Lots reviewed its operating strategy in late 2018 and early 2019. That produced what it calls a "plan for a strategic transformation."

That plan is given credit for recent successes and improvements. For example, President and CEO Bruce Thorn wrote in a second-quarter business update:

"Looking forward, our strong performance over the past few months gives us growing confidence that we are well positioned to navigate through the upcoming quarters and beyond. In addition, our strong liquidity position will support our ability to return cash to shareholders through share repurchases, while continuing to invest in high-return growth initiatives under Operation North Star."

In addition, Big Lots has embarked on a what appears to be a successful omnichannel initiative, which means it is operating on a cross-channel rather than multi-channel basis.

In a November news release, the company announced it had been named #1 in TotalRetail's 2020 Top Ominichannel Retailers Report. It added:

"The company was recognized for their omnichannel capabilities, including a number of recent customer service innovations in both brick-and-mortar stores and online. Criteria included the ability to buy online and pick up in-store, search and shop for in-store products online, seamless returns and loyalty programs. The list reveals the retailers and brands at the forefront of delivering seamless cross-channel shopping experiences that serve customers in multiple ways, often in the same purchase journey."

Operation North Star and the omnichannel operations have had a positive effect on same-store comparable sales. This year it has reported these comps:

  • First-quarter: Up 10.3%.
  • Second-quarter: Up 31.3%.
  • Third-quarter: 17.8%.

Not surprisingly, such results helped push up share prices since the March collapse:

Big Lots share price

Despite the increasing price, Big Lots has a price-earnings ratio of just 2.87 and a PEG ratio of 0.24, both indicating the stock is undervalued, and because it has a business predictability rating of 3.5 out of 5 stars, we can be somewhat confident in its discounted cash flow (DCF) valuation:

Big Lots DCF calculator

With a current dividend yield of 2.66% and a three-year dividend growth rate of 12.6%, Big Lots could have a yield of 6.09% in five years. What's more, it has been reducing its shares outstanding by an average of 7.18% per year over the past decade.

At least some gurus liked what they saw, and acted accordingly, as more gurus have been buying the stock than selling it in recent quarters:

Big Lots guru buys and sells

The top three among the nine gurus who have holdings in the stock are:

  • Jeremy Grantham (Trades, Portfolio) of GMO LLC, who was a big buyer in the third quarter, increasing his stake by 159.4% to take the count to 571,961 shares, representing 1.46% of Big Lots' shares outstanding and 0.18% of GMO's assets
  • Jim Simons (Trades, Portfolio) of Renaissance Technologies, who cut his stake by 3.63% to finish the quarter with 426,900 shares
  • John Hussman (Trades, Portfolio) of Hussman Strategic Advisors, who added another 41.67% to his stake and wound up with 102,000 shares at quarter's end.

Conclusion

Big Lots has found a path to success with its growth strategy. Whether it can maintain its growth and profitability over the next five to 10 years is unknown, but it trades at a discount according to several key metrics.

I think Big Lots will be of interest to value investors who are comfortable with some debt on the books, as well as growth investors looking for capital gains and income investors looking for growing dividends.

Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


Rating: 4.0/5 (1 vote)

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Comments

Praveen Chawla
Praveen Chawla premium member - 4 months ago

Good article. Most of the debt is actually capital lease obligations, which was always there but due to change in accounting rules has to be now shown on the balance sheet. You will notice the BIG's gross margins are impressive (much higher than Target) Is it sustainable?

Robert Abbott
Robert Abbott premium member - 4 months ago

Thanks,Praveen, it's good to hear from you again!

Over the past ten years, the gross margin has ranged in a narrow band, between 40.70% to 39.17%, so the odds seem good it is sustainable:

https://userupload.gurufocus.com/200877/0e7575afd61170d906b57d22bb9d19e7.png

Indeed, if omnichannel sales continue to grow (in relation to total sales), the margins might look even better.

You made a good point about the capital lease issue, which makes sense for a retailer.

Bob

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