Finding Big Value in Big Lots
By Brad Lightner
As the economy continues to struggle and discretionary spending tightens, consumers are pinching pennies and looking for any way to save a buck. Stock price run-ups in companies such as Wal-Mart Stores Inc. (WMT) [53.12, -1.32 (-2.42%)] have proven this simple economic theory valid.
Although investors tend to shy away from discretionary companies in economic downturns, one sub-sector that has remained strong through the storm is general merchandising stores. As of September 5, 2008, the S&P General Merchandising Stores Index was up 16.4% year-to-date, while the S&P 1500 Index fell 14.5%. Going into the holiday season, there is still value to be found in this industry.
Now you may be asking yourself, given the current state of the economy, where is there value to be found? The answer to that question lies in Big Lots Inc. (BIG) [21.25, -1.86 (-8.05%)].
Big Lots is the nation’s largest broadline closeout retailer, operating 1,355 stores in 47 states. Their company strategy is targeting middle class shoppers seeking to save money on brand name closeouts and other discounted merchandise. The company operates in six segments:
- Consumables (food, health and beauty, plastic and paper products)
- Home (home decorations, stationery)
- Furniture (ready-to-assemble, mattresses, upholstery)
- Hardlines (electronics, appliances, tools, and home maintenance)
- Seasonal (lawn and garden, Christmas, other holidays)
- Other (apparel, toy, jewelry, toys, infant accessories)
Strong Business Strategy
In 2005, Big Lots implemented their “WIN” strategy with three distinct phases: Discovery, Testing and Learning, and Execution. The Discovery phase used decisions to improve near-term performance, while the Testing and Learning phase implemented merchandising, marketing, and operating to understand their business potential. Currently, Big Lots is in the Execution phase, which contains strategies to expand operating profit rates, driving growth in earnings per share, and generating cash to invest into their business or return to shareholders. So far, they have been successful in this stage as earnings per share increased from $1.01 a share in fiscal year 2006 to $1.47 a share in fiscal year 2007.
The value to be found is within their merchandising and real estate strategies, where Big Lots is expanding market presence in new and existing markets. The merchandising aspect includes the “raising the ring” strategy, where the company offers a mix of items with higher than average item retail sales prices, such as larger packages or quantity sizes. This leads to higher comparable store sales while keeping distribution center processes lower. Their real estate strategy involves closing unprofitable stores and focusing assets on stronger performing stores in the Northwest, West, and South, while avoiding overpriced real estate leasings to deliver store unit growth. This company knows when to cut their losses, and they are able to focus their attention on profitable stores to help increase sales and company value.
Sub-sector Appeal
As stated before, general merchandising stores have prospered in the first half of the year. This is likely to continue towards the end of 2008, as the economy continues to see macro economic pressures that force consumers to rely on discount retailers and wholesales. These stores are seeing more food assortments which allow them to compete with drugstores and convenience stores for market presence. Discount retailers such as Big Lots are able to profit from increased levels of direct sourcing, as they maintain relationships with vendors and merchants to keep product costs low, which in turn allows margins to increase while keeping prices relatively constant. In the second quarter of 2008, Big Lots’ selling, general, and administrative expenses were down 30 bps, showing efficiency in their store and distribution centers.
Below is a one year stock chart of Big Lots and its competitors, with BIG denoted in blue.
Favorable Financial Valuation
Big Lots’ financial valuation is one of the reasons why BIG is an appealing investment. According to an analyst from Wedbush Morgan Securities, Big Lots has traded at a five year forward P/E average of 20.1x, while the industry is currently trading at a forward P/E average of 16.5x. According to Yahoo! Finance, Big Lots is currently trading at a forward P/E of 12.9x, clearly showing that the company is undervalued on a P/E basis.
Big Lots will also see increasing margins from their lower costs of merchandise, higher initial markups of new products, and global sourcing, where Big Lots receives 25% of overseas inventories. According to Bloomberg estimates, they are expected to see profit margins increasing at 15.43% through 2009.
Additionally, Big Lots had a massive share repurchase program in 2007, where $600 million was authorized in March of 2007 and $150 million was additionally authorized in November. Overall, Big Lots bought 30 million common shares with an aggregate cost of $712.5 million at an average price of $23.76.
Moving Forward to 2009
Moving towards 2009, management has provided comparable store sales guidance of 1-2% for the third quarter and 1-2% for the fourth quarter. These estimates seems low, especially considering they had comparable store sales of 2.8% in the second quarter, even as consumer spending began slowing. Big Lots reports earnings on November 25 before the bell, so look out for that earnings call, as it will provide additional clarity for their business going into 2009. Anyway you look at it, Big Lots is an undervalued company with a strong business strategy in an appealing sub-sector.
Disclosure: The mutual fund the author is associated with is long BIG.
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