What if I told you there was a company with an average ROE > 22% over the past 10 years… It also earns a double-digit ROIC… What if I told you that this company was a beneficiary of COVID, and the cash flow greatly increased its future optionality for years to come? What if I told you this company also has been a consumer of its own shares – especially in market volatility (i.e. when you want it to be buying shares). The title gives it away, but I am talking about Big Lots stock.
Yes, I’m sorry readers. This is a value stock (vs. some SaaS-y growth stock). Brick and mortar retail, no less.
The stock is now down ~14% after posting Q3’20 results. While the company posted 17.8% SSS comp (a record), they noted some deceleration (perhaps too much pull forward of Holiday shopping into Black Friday + they closed early on Thanksgiving). Even so, the deceleration meant Q4 was looking like a +Double-digit Q, and their gross margin guidance seemed conservative, so I thought I’d take a deeper look.
There are several reasons why I think there is significant upside to the stock with reasonable downside protection — including some things to assuage the B&M concerns.
The quick and dirty background on Big Lots is its a discount retailer with its foundation in the south and south west, mainly opening up in strip malls (typically an “anchor” tenant). They have ~1,400 locations today, but if you haven’t heard of them it’s because you aren’t in a location they target (more suburban and rural and where the ~30% discounts to other retail they offer are appealing to the price conscious).
There’s a debate over whether companies that have strongly benefitted from COVID will give back all of the gains they’ve seen this year. In some cases, like in SaaS, investors see a sticky business with low attrition. So it appears investors are saying SaaS will give no sales back post-COVID. In fact, the street is saying they’ll continue to grow. I’m not saying that is wrong, but for retailers, they are saying the opposite.
For example, people are stuck at home. They aren’t traveling, not going to restaurants, so they’re spending on making the home better. Dollars have shifted from some sectors and into other sectors. As COVID ends, people travel more and go to restaurants, there will be less dollars to go around and they’ll cut back on the beneficiary-of-COVID sectors.
I agree with this generally. Clearly Big Lots is making more sales than ever. These comps it is posting are unsustainable and it will likely post sales declines comps next year.
However, this also didn’t come for free. On BIG’s Q1 call, they noted they canceled their annual Friends & Family event, gave their employees Easter off (which is typically a big sales event), gave a temporary $2-hr wage increase, provided an additional 30% employee discount, and additional bonus pay. So looking forward, its not just so easy to say the sales comps will reverse.
I really like the option value of Big Lots. The boost from COVID has done 3 things. And if the term wasn’t overused, I’d say it’s a flywheel – each of the factors reinforces the others:
- Improved comps, therefore operating leverage, allowing them to generate a ton of cash flow
- Big lots YTD has produced about 3x as much FCF as it did last year ($267MM vs. $80MM PY). It also did a sale & leaseback transaction in Q2 to generate $587MM of cash.
- Q3 is a working capital investment Q ahead of the holidays, but I could see them ending the year with >$700MM of cash
- Big Lots is also coming off of a capex spend, so future cash flow should also look better
- Accelerated competitiveness of Big Lots and its strategic plan
- Without COVID, I wonder if Big Lots would have accelerated as quickly with Buy Online, Pickup in Store… or E-Commerce (which is probably small, but up 50% in the Q)
- They also now have >20MM people on their rewards database
- Sure, a lot of retailers have had to adapt, but there could be something to the theory that struggling retailers (both big and small) will close some locations and post-COVID, the playing field may be altered
- Introduced new buyers to the concept
- With COIVD impacting so many businesses, and a lot of them shutting down, there’s no question that Big Lots benefitted from increased traffic. The question is – can they convert some of those new buyers into repeat buyers?
- As of right now, the market doesn’t appear to be giving Big Lots much credit for this. In fact, it seems to be getting the least credit out of the few comps I looked at
- However, as I noted, Big Lots actually does have really good deals. And they are focusing on a market with tailwinds (furniture, home decor, which I speak about later). Couple this will more rewards customers and I think its unfair to say they can’t retain much business
These are intertwined. But the issue with Big Lots, and why its multiple has been halved over the past few years, is that people view the company as being in secular decline.
The WHOLE POINT of this post is to say, I think that may be too pessimistic
But take a look at what mgmt is saying it is investing in and able to do right now. I ask myself, “is this company getting better or worse in the future?” and “is my downside well protected?”
In fact, I can’t think of a better strategy to adopt pre-COVID – mgmt’s strategy has been focused on increased home furnishings. Mgmt is probably thinking “I’d rather be lucky than good” — targeting the home was a good idea.
For more background, Big Lots had basically grown nominally the past 12 years. They got a new CEO in 2018 which helped oversee a refresh of the stores, put the best categories up front, and accelerated online investments.
Furniture is a high margin category and they purchased Broyhill, which allows them to offer indoor and outdoor discount furniture (note: Broyhill is on track to do $400MM of sales this year – this is an asset they acquired at the end of 2018 for $15.8MM). Food is fiercely competitive, so they are deprioritizing that.
The issue with this original plan is how they will inform buyers they offer / are expanding in core categories – it is clear traffic was up this year, so perhaps that will help going forward.
The other factor is that we clearly had a major recession. Big Lots is a discount retailer, typically trying to offer goods at a sizeable discount. These sort of end markets tend to have tailwinds after a recession (see my AZO post), albeit this recession may be brief.
If you’re thinking, “ok this is good. I just hate the legacy brick and mortar exposure.”
The good news is 684 leases expire through 2022. That is almost half of their locations. In my view, BIG is in a much stronger negotiating position since the strip malls they tend to sit in may have been hit hard (i.e. anchor tenant leverage).
Second, if they need to “right size” their footprint, BIG can walk away, liquidate inventory, and invest elsewhere…. Including locations it thinks may be more profitable.
I don’t think Big Lots is in a bad position and I think the stock is cheap. There are upside to my numbers here below, yet the stock trades at just 5.8x 2022 EPS. For context, Dollar General trades at 22x, AZO trades at 13x, Home Depot at 20x, Ross Stores at 22x. Maybe the best comp is Bed, Bath and Beyond trading at 10x ’22 EPS and they’ve had much worse performance than BIG… the list goes on.
Ok – so some of those comps have performed better and earn a higher ROIC than Big Lots. But BIG also has the lowest expectations priced against the lowest multiple. And I view the downside risk as pretty limited.
For example, based on my estimates, the company trades at just 5.8x EPS. If it were to trade at 10x EPS, you’d have a $78 stock, or ~65% upside from today’s levels.
You can also tell the company gobbles up its shares and I expect that to continue. The company repurchased $100MM of stock and has $400MM of remaining authorization (that’s around 25% of its market cap – which it could do given the cash). That eventually will grind EPS back up to the peak we may have seen this year, especially if the stock price doesn’t react.