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.
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.