Big Lots in Elkton, MD
Enterprise Value = $1.859 billion
Operating Income = $274.5 million
EV/Operating Income = 6.77x
Price/Revenue = .32x
Earnings Yield = 10%
Debt/Equity = 25%
Big Lots is a large discount retailer. They operate 1,400 stores throughout the continental United States along with a smaller operation (89 stores) in Canada. Big Lots sells everything from candy to furniture, all at a steep discount. Traditionally, Big Lots acquired their inventory by taking advantage of closeout situations. A closeout is a situation where a major vendor wants to bulk dump the last of their inventory on a firm like Big Lots. Big Lots buys the inventory in bulk (it can be completely random – like Keurig machines or inflatable pools) at a steep discount, and they sell the items to their customer at a low price.
This isn’t the only way that Big Lots acquires inventory, but closeouts have traditionally been the core of their business. Their big sales on closeout items are typically what attract customers to the store, who also make impulse purchases on goods that aren’t as attractively priced. Quickly perusing deals on their website, you’ll see that they frequently sell goods at a discount to both Wal Mart and Amazon.
Inventory management and ability to secure merchandise deals are a major part of their business. They have a long track record of successfully navigating this difficult industry, with the business dating back to 1967.
The stock is down 12.8% in the last year and is 35.9% off its 52-week high which was reached in January of this year. The stock is afflicted by the “retailpocalypse” sentiment. At the first sign of trouble, retail stocks are absolutely crushed in this environment.
The past two earnings reports were greeted with horror by Wall Street, hence the steep discount from the 52-week high and ultra cheap valuation. In the most recent earnings report, earnings were down 39% from the same quarter a year ago. Revenue was also slightly off.
Big Lots is priced like a business that is in severe distress even though it isn’t. Wall Street overreacted to the recent earnings reports just because they are on high alert about any minor hiccup in the retail sector. It’s a good company in a hated industry.
At the current P/E of 10.41, if the stock returned to its average valuation over the last 5 years (16.41), it would be a 57% increase from current levels. For what it’s worth, management expects to earn $4.50 per share this year, which is pretty close to what it made last year. They are not warning of significant deterioration. If the business situation improved just a little bit, I don’t see why the stock couldn’t return to its average valuation multiple.
One of the major risks facing Big Lots is a trade war. They are heavily dependent on cheap goods from overseas markets to support their pricing model. If a trade war truly did happen, Big Lots would be harmed. At the moment, the threats going back and forth between the United States and China seem small and are likely posturing.
Interestingly, Big Lots actually delivers higher returns on capital than its biggest competitor, Wal Mart. Big Lots earned a 10% return on assets, compared to Wal Mart’s 4.43%. Wal Mart’s operating margin is presently 4.3% compared to Big Lot’s margin of 5.24%. Indeed, Big Lots is hanging in there and doing well even though it is competing with brutal competitors: Wal Mart, Amazon, and dollar stores.
There are also no signs of financial distress: they have a 25% debt-to-equity ratio, an F-Score of 5 and Altman Z-Score of 6.88. The decline in the stock seems driven solely by a minor drift down in performance, nothing major.
Like Aaron’s, I think Big Lots is a company that should benefit at this point in the economic expansion. Discount retailing is an industry that should thrive as the lower and middle class begin to feel more confident about their jobs and spend more money on discretionary items.
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