Big Lots: Big Value, but Not Yet

Big Lots Inc. (BIG, Financial) operates discount retail stores. The company retails a broad range of merchandise, including food, consumables, soft home products, hard home products, furniture, electronics, accessories and seasonal products. It sources its merchandise from both traditional and close-out channels. The company operates stores throughout the United States, with around one-third of its stores in California, Texas, Ohio and Florida.

The Columbus, Ohio-based company operates on a rare type of business model by purchasing excess merchandise directly from manufacturers that generally results from production overruns, packaging changes, discontinued products or returns. As a result of the lower purchase cost, it can generally offer most merchandise at prices lower than those offered by a traditional retailer.

Source: Big Lots investor materials

It's a great business model, at at first, one might think the company is in for higher earnings due to out-of-control inflation and a weakening economy in the U.S., which would drive more customers to discount retailers like Big Lots. However, while the company's prospects look good, now might not be the best time for the stock, in my opinion; here's why.

Business breakdown

Big Lots operates a total of 1,438 Stores in 47 U.S. states. Its stores are predominantly in strip shopping centers, and have an average store size of approximately 29,600 gross square feet, of which an average of 21,300 square feet is selling square feet.

The company offers closeout merchandise, including consumables, home, seasonal and toys and other. The consumables include food, health, beauty, plastics, paper and pet departments. The home products include furniture, domestics and home decor departments. Seasonal and toys includes toys, lawn and garden, trim-a-tree and various holiday-oriented departments. The other products include electronics, apparel, home maintenance, small appliances and tools.

Big Lots provides a unique kind of shopping experience for its customers. Many of them view it as a treasure hunt and like it much better than the traditional retail experience. The company offers tremendous values that other stores simply can't match. They are the nation's largest broadline closeout retailer and have the purchasing power to locate and negotiate the best deals in the business.

Recent results

Big Lots was a big pandemic beneficiary, as can be seen in the chart below. Revenue increased substantially and earnings spiked, but the bottom-line is now coming back down. Earnings per share turned negative because of excess inventory buildup, which the company is now scrambling to clear out at a loss. Comparable store sales dropped 17% in the first quarter of 2022 on a year-over-year basis.

Below are some of the key highlights from the company's first-quarter 2022 earnings report:

• • Three-year comparable sales growth of 2% in Q1, with significant slowdown in April as consumers felt spending pressures.
  • Q1 EPS loss of $0.39 due to year-over-year sales decline and significant cost pressures.
  • Three-year comps for May running up mid-teens as promotions drive compelling value proposition; focused on unlocking additional sales opportunities (i.e., better opening price points, closeouts, trade-down demand).
  • Expect sequential improvement of gross margin in each of each of Q3 and Q4, with Q4 margin approximately in-line vs. prior-year quarter.
  • Incremental SG&A cost savings of $70 million in fiscal 2022.
  • Temporarily scaling back capital expenditures in fiscal 2022 to strengthen balance sheet.

Short-selling

The company is currently under attack from bears with a 42.32% short percent of float. In other words, speculators are betting that stock price will decline further. Also note that the stock is much more volatile than the market with a beta of 2.32.

Financials

Big Lots' financial condition is quite decent. Most of the liabilities are leases for stores and distribution centres. The company has strong interest coverage. The company's Altman Z-Score (a measure of risk of bankruptcy) is quite good at 3.24.

The company has been buying back its stock at a prodigious rate. Last year it bought back 19.86% of outstanding common shares.

The company's dividend is excellent, as shown in the below chart. The insider ownership level is good, so executives have "skin in the game," which is a positive sign. Another thing to note the very high institutional ownership of the stock.

Conclusion

Big Lots' fundamentals certainly appear to be compelling. It is selling at historically low price-earnings and price-sales ratios ratios. The ratios are not too far from the March 2020 Covid selloff lows and lower than the Great Recession.

However, in spite of tempting fundamentals, the high short interest in the stock gives me pause. It looks like too many investors are expecting another shoe to drop. The company does attract an inordinate amount of short interest because of its volatility, but right now the short interest is extreme.

Source: Morningstar

The other thing that bothers me is the still high inflation and high gas prices. Big Lots' demographics are predominantly low income and lower middle-income shoppers, who are discouraged by the sudden rise of inflation and have pulled back spending, as evidenced by weak numbers printed by retailers such as Target (TGT, Financial) and Walmart (WMT, Financial).

Retailers had built up a large inventory during the home goods boom last year, which will now have to be unwound, so the company will be in for a few tough quarters. I would like to see some evidence that inflation is under control before I take a chance on a high beta name such as Big Lots. I think the stock will eventually be a strong value proposition sometime later this year or early next year as we get more clarity on the inflation story and the short interest goes down, but not just yet.