Tag: BIG

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Re-examining Big Lots Stock – Case for Optimism? $BIG
Reading Time: 4 minutes

It’s a start of the new year, and the end of a year where the S&P500 was down nearly 20%. Some may focus on what worked, I’ll look at an idea that did not go well. Big Lots stock, down 68% in 2022, it’s market cap is just ~$425MM.

I think there’s still room for optimism (even if its just a “dogs of the Dow” type of viewpoint). This bagholder just won’t quit. Mainly because I think the stock is trading at ~3x FY’24 EBITDA, 8% dividend yield, with some upside if they continue to sell some assets.

Don’t get me wrong. Don’t take this as “Big Lots stock is my largest position.” Far, far from it. Could we go into a recession? Sure. Am I happy that FCF may be mediocre despite the low EBITDA multiple? Of course not. That’s why position sizing is important.

That said, from here the stock looks interesting (even if that means when I first wrote it up was much too high). This could be one to add to the radar at the very least. I’m also looking out to 2024. So if you’re someone who is looking for something that will definitely do well this year, not sure this is the place. Especially because if under this new lens it just looks “interesting”, then it probably has a bit more downside before the upside arrives (just my experience).

I think my biggest mistakes in 2022 were buying low-quality business that seemed like they had tailwinds. Things can quickly change, tailwinds can evaporate, and you’re left with a low-quality business! It worked for awhile and then it really did not work…

Retail is a tough business. That’s apparent right now where many are caught with too much inventory (in the face of destocking), mark downs are evaporating profits and working capital has eaten liquidity. Freight and labor have also been challenging.

What makes this a particularly bad pick for me is I’ve been calling for the bull whip to play out for some time now and this is a clear example (here and here).

But I really liked what Big Lots was doing – pivoting store formats, bought brands with staying power (Broyhill), improving cost structure and growing stores to help absorb fixed cost leverage. I still think all of those are true. But as I’ll show below, they really got hit with freight, promotional activity, and labor costs.

Theoretically, the challenges mentioned above should be “one time” in nature, or at least cyclical problems, not secular. And they are all known now, at least I think they are…

I built a waterfall chart from 2019 to show the pressures Big Lots has seen. But just to rehash in FY2022 (which will end Jan’23, so Q4 is still an estimate).

  • Sales will have declined ~11%
  • GMs down >400bps
  • Opex up as a % of sales >350bps

Big Lots ended 2019 with ~6.5% EBITDA margins, so no surprise it is now negative.

But when you break down the reasons, Big Lots has called out freight being 400-500bps of operating margin pressure via GM and Opex. And they said that has peaked at this point. Promotional activity has peaked, too.

Looking forward, Big Lots has already faced destocking as mentioned. If we assume modest sales growth to 2024 and some of these headwinds abating, I could see Big Lots easily getting back to $255MM of EBITDA in FY’24 with some reasonable assumptions.

Bridging Big Lot’s EBITDA from 2019 to the current year to my expectation a couple years from now

With a ~$425MM market cap and ~$825MM Enterprise Value, that means Big Lots stock is trading at 3.2x EBITDA!

Is it the cheapest retailer I have ever seen? No. But I think that multiple could look even lower given more asset sales are on the come:

I have no idea what these assets could sell for. Back in 2020, they did a sale leaseback of 4 distribution centers for a gross amount of $725MM (net proceeds was more like $575mm after taxes and such). That’s not really a comp, but was interesting how low book value was compared to the actual proceeds (recorded a $463MM gain on sale).

I did find several listings of Big Lots stores that ranged anywhere from $2.5-$4.5MM (honestly averages in the middle). If it could sell 25 stores for $2MM a piece, that is $50MM gross. There’d probably be $3.5MM of incremental rent expense as a result, but that’d still be a win in my book given where the market cap is.

Big Lots has nearly $720MM of PP&E on its balance sheet. Selling assets at better than a 10% cap rate is accretive given Big Lots stock is trading at such a low multiple. It helps liquidity and can help pay down debt. I’ll take it.

While dangerous to anchor on, let’s not forget book value is $27/share.

As I mentioned at the top, a big concern here is $255MM of EBITDA may not generate much FCF. They’ll probably spend $170MM on capex per year (albeit to grow stores). I think with interest the stock is probably trading at a 10% FCF yield at best.

So one to watch. I still think this business and brand are underappreciated long-term. But alas, buying low-quality businesses even at cheap prices can be a dangerous game.

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Leaning into Value Traps that Everyone Hates… and a New Name, Strattec $STRT $AXL $ALSN $CATO $ANF
Reading Time: 5 minutes

There are certain businesses that investors have washed their hands of: Retailers, OEM auto suppliers, anything in the way of ESG… many others… And this trade probably worked well for the last 5 years. I recently wrote up at least three names that are counter to these trends, but there are many more.

I’m in the process of creating a “basket” of these names that I’m going to commit to buying and holding for at least 3 years.

I’m calling it: the Value-Trap Coffee Can portfolio.

Most of the time, a coffee can portfolio is set up of really good businesses that you should just set and forget. Let them compound.

In this case, the narrative around some stocks can be so toxic, you can convince yourself at any point to sell. But if find management teams that are very savvy, conducting effective turnarounds despite headwinds, and know how to drive shareholder value, sometimes you still want to align with them.

I fundamentally believe you can have bad industries, but great companies (driven by great management teams) and therefore great securities hidden within them. 

So I’m locking these stocks up and throwing away the key to see what happens.

So far, the Value-Trap Coffee Can (VTCC for short) portfolio includes Allison Transmission, Big Lots, and American Axle, but I am also adding Cato (recently discussed on Andrew Walker’s podcast with Mike Melby at Gate City Capital), and Abercrombie and Fitch (written up on VIC, but down nearly 20% since then). After looking into the latter two, I’m convinced they’ve earned their spot. They aren’t my ideas though, so I won’t be writing them up.

I am adding Strattec to the VTCC portfolio, which is an automotive supplier and I’ll get to at the bottom of this note.

Please reach out if you have any others I should be looking at!

Why the VTCC Portfolio Now?

At points in the past, this would’ve seemed nuts, but my response to that is these companies

  • have significant cash / FCF, especially compared to their market caps today
  • have a rising earnings path over next ~12+ months. Especially true now that we went through a downturn and are coming through on the other side of it, and
  • are completely unloved, so are still very cheap.

You can see it’s really more of a cycle + cheap call.

I cover cyclicals for my day job and cyclicals have been pretty much un-ownable since we had an industrial-recession scare back in 2015/2016. OK – they had a nice run when Trump first came in, tax cuts were implemented, and there was a brief sugar high – but after that, the stocks didn’t do well by comparison even if results were fine. I saw many companies I covered trade at super low multiples as everyone figured a cycle was inevitable.

I now think that since we may be entering a new cycle, permission to own is granted.

In other words, maybe value traps won’t be traps for too much longer. (Famous last words DillyD!) But seriously, you can mitigate this problem via position sizing.

A couple pushbacks to that simple thesis:

  • You could completely disagree with me that we are entering an upcycle – people are already saying what we went through in 2020 doesn’t count as a “normal” recession (whatever that means) and is more like a natural disaster. Semantics. Whatever. This is the theory I have and am going to bet that way.
  • Stocks already at all-time highs, too. So how can there be much of a recovery? Well… FANG is like 25% of the S&P500. None of these basket stocks are in tech.
  • Supply chains are a mess. This could derail the thesis, but I think it would be a temporary derailment vs. anything long-term.

It seems very hard to argue to me that any of the sectors I am going to buy a basket of are “overbid” territory. We can also reach new highs if FANG stocks stay flat and cyclicals have a really nice run, too, ya know?

I think retail is interesting because the consensus narrative was that they are dead, that we pulled forward a ton of e-commerce progress… and yet, if you actually looked at some of these player’s results, you’d see they either adapted very well (some did) or the buyer is coming back.

The anti-ESG trade is only interesting to me in names that can solve the problem – by buying back stock themselves at really attractive prices. Some names are in the ESG crosshairs, but either can’t or are unwilling to effect change in their share prices.

Why Strattec?

Strattec is an interesting little auto supplier that makes locks, power lift gates, latches, among other things. It was originally spun out of Briggs & Stratton in 1995. Here’s a [kinda hilarious] video of them trying to sell why people need a power lift tailgate.

They have their OEM concentration issues, like American Axle, but that is the name of the game. They actually have much better concentration than American Axle which you can go see in their 10-k.

Similar to my American Axle thesis, I think we are going to need a massive restocking of cars. Inventory days are ~22-23, compared to the normal 50. However, this cycle is going to take a long time to sort itself out.

Unfortunately, Strattec was impacted by plant shutdowns due to lack of semiconductors. This is disappointing as the company wasn’t able to sell as much, particularly in its award winning power tailgates in the Chevy Silverado and F-150 pick-ups.

But it’s a double-edged sword. The longer it takes to replenish inventories to “normal” the longer this auto upcycle will likely last. Yes, less sales today, but I think the tailwinds will be there for some time to come. Again, I wrote about all of this in my AXL post.

Even with these headwinds, Strattec still did $110MM in the latest FQ4 (ended June, reflecting the impact of the semi issue) and $485MM for the FY, down from $129MM in the quarter ending June 2019, but in-line for the FY $487MM. However, EBITDA increased by ~50%. Again, this was due to cost improvements and efficiencies in the business that the company says is structural.

Bottom line, I think Strettec will emerge more profitable than ever, and if permitted to run flat out (semi issue abates somewhat) then we will see awesome fixed cost leverage, too.

Strattec Valuation:

Strattec is only a $150MM market cap company, but an enterprise value of ~$147MM.

Over the past 12 months, they cut their dividend during the COVID panic and paid down $23MM in debt. If you fully count JV debt, they have $12MM in debt now, but $14.5MM in cash.

At the same time, let’s say you expect the top line to grow a bit, but they’ll give some margin back, the company is trading <3x EBITDA. And it isn’t like that EBITDA won’t convert into FCF: the company has guided to $12MM in capex, they’ll have no interest expense (basically) and taxes in the range of $8-10MM. That’s $35MM of FCF on a $150MM market cap company.

Not bad! Just last 4-5 more years and I’ll have my money back.

Columns, Earnings Recap

Earnings Check-in: $BIG Let’s Not Miss the Forest for the Trees
Reading Time: 2 minutes

$BIG reported today, August 27th and it was a miss. Guidance was also worse than expected.

  • EPS was $1.09 vs. $1.12 consensus
  • Comps were -13.2% vs. -11.4% consensus (but they were lapping a +31% Q)
  • ’21 EPS guide was $5.90-6.05 vs $6.66 consensus, with the company calling out freight and supply-chain challenges.

This is a common theme among retailers to-date. Another favorite of mine, Dollar General, reported some similar issues.

That said, it is hard for me to call this quarter “ugly.”

  • On a 2-year stack basis, sales comp’d +14%. They said so far in the next Q, they’re ahead of that.
  • As I noted in my original post, $BIG now has no debt, but is flush with cash. This is tremendous option value and they still have $293MM  left in cash (they typically might carry just $50MM).
    • They bought back ~$400MM of stock, I expect that to continue, and isn’t too shabby for a company showing $1.67BN market cap at the time of writing. Share count is down ~12% since their FYE.
    • They announced they’re using some cash to “refresh” 800 stores (a bit more than half their stores), but it’s a modest $100k per store refreshes. I imagine this is high-return investments.
    • They’re adding new stores in ’21, about 20, but noted they will 2-3x that pace in the future. Gaining scale is important for their relatively small footprint.  As a reminder, they’ve been a net store decliner over the past 5 years, but now they’re positioned for growth. 
  • They’re rolling out 2 forward DCs to help with supply chain and delivery. These are the first in the co’s history.
  • Furniture continues to comp well and this is what they’ve centered their stores on. I like that exposure.
    • Broyhill continues to chug along to being $1bn brand. They also noted, “Real Living” brand is set to be $1bn brand too.
    • They are adding sales staff specifically focused on helping folks buy furniture. In test markets, it resulted in a 15 point increase in sales. As they roll this out to more stores, they expect a 1 point increase to comps in 2022. Next imagine it rolled out to 1,400 stores…

On the call, they also stated, “Moving into Q3, our inventory situation has improved, and we have seen a resurgence in sales with early strength from our Halloween and Harvest assortment. Although supply chain pressures related to Asian port and manufacturing disruption will continue to create challenges, we are much better prepared to win at the all-important holiday season.”

So where I am sitting, I still like the story. Again, at the time of writing, the market cap is $1.67BN. However, they do have $293MM of cash which it seems like they can reinvest in the business.

Even with the guide down, the stock is trading at 6.6x EPS ex-cash. That seems too cheap to me. If the market wants to price $BIG as the same story as what it was 2,3, 5 years ago, I think that is incorrect.  Supply chain woes will be temporary in my mind as well.

 

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Hear Me Out: Lots to Like about Big Lots Stock $BIG
Reading Time: 6 minutes

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:

  1. 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
  2. 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
  3. 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.