BIG - Big Lots: Big Challenges

2023-07-16 12:14:35 ET

Summary

• Big Lots has seen a very large and painful retreat post the pandemic.
• Profits from sale-and-lease-back transactions have been squandered on share buybacks, while adding rent to the operating expense base of the business.
• The company is facing real losses now, has taken on some debt, and is resorting to its last sale-and-lease-back card.
• The situation is highly fluid and uncertain. I see no need to get involved with this battleground stock.

In the summer of 2020 I concluded that shares of Big Lots ( BIG ) were seeing big gains after a big performance. The company was on fire on the back of accelerating operating performance after the initial scare reaction from the pandemic, as a big sale-and-lease-back transaction resulted in a massive cash influx. Despite these positives, I feared that earnings were not representative going forward and hence the risk-reward was not compelling.

This has played out in its entirety, and some more, as proceeds from the real estate transactions were used for too expensive buybacks, with Big Lots now saddled with a debt load, a higher expense base and lack of demand in a tougher and uncertain environment.

My Former Take

When I looked at Big Lots in the summer of 2020, the near term investment story was dominated by a massive $725 million sale-and-lease-back deal for its 4 distribution centers. With net proceeds pegged at $550 million, and no rental details being announced, one had to make some assumptions. Pegging rents at 6-7% of the gross value, Big Lots would incur $43-$50 million in annual rental payments in exchange for $550 million in net proceeds.

This came as the business posted a 1% increase in 2019 sales to $5.3 billion (pre-pandemic), with operating profits falling to $156 million, indicating how thin the margins of the business were. The sale and lease back transaction would turn a $230 million net debt load by the end of 2019 into a net cash position of $300 million, equal to $7 per share.

This came as 2019 earnings fell a dollar to $2.70 per share, although that incremental rental expenses (offset by interest payments) made that GAAP earnings would fall to $2 per share. Already a $20 stock pre-pandemic, the resulting multiples felt very compelling, but long term concerns were visible.

After posting an 11% increase in first quarter sales, the company guided for second quarter sales to grow by 25-30% which on top of the sale-and-lease-back transaction created quite come enthusiasm, with earnings in the second quarter seen as high as $2.50 per share (essentially equal to the annual earnings power). This caused shares to rally to $43 per share, but being wary of extrapolating those earnings, I was quite cautious.

Too Cautious - At First

The momentum run in the shares of Big Lots continued as shares rose to a high of around $70 in spring of 2021. Ever since, it has been steady downhill, with shares ending the year 2021 around the $40 mark, and 2022 around the $15 mark. By now, shares trade at $8 and change, after even briefly trading with a $4 handle.

After posting very strong results in 2020, Big Lots posted a small decline in the 2021 sales numbers, as reported early in 2022. Full year sales fell from $6.20 billion to $6.15 billion, albeit due to very tough comparables. Operating profits of $240 million came in at 3.9% of sales, down from 6.3% in 2020 (if we adjust for the sale-and-lease-back gains).

With earnings surpassing $5 per share, investors were upbeat, although that much of the net cash position following the sale-and-lease-back was earmarked for share buybacks, depleting the net cash position. With shares trading at $40 at the time, it was clear that investors were cautious to extrapolate that earnings power going forward.

In March of this year, Big Lots posted its 2022 results, and they were not pretty. Despite inflationary impacts, revenues fell from $6.15 billion to $5.47 billion. That was just part of the bad news, as the deleveraging resulted in huge pressure on earnings, in fact Big Lots posted a $261 million operating loss, equal to 4.8% of sales.

These losses made that the company took on a quarter of a billion net debt load, worrying given the continued losses, as all the money from the 2020 sale-and-lease-back has been used to buy back stock, reducing the share count to just 29 million shares here. With shares trading at $15 when the number was announced, the market value has fallen to just $450 million, less than the proceeds from the sale-and-lease-back transaction, for a $700 million enterprise valuation.

In May, Big Lots posted dismal first quarter results, with first quarter sales falling by 18% to $1.12 billion and operating losses posted at $261 million. This resulted in a huge $7.10 per share GAAP loss and adjusted for costs related to the exit of leases, losses still came in at $3.40 per share, roughly half that number, a huge loss by all means. Moreover, net debt rose to $450 million, with debt rapidly coming out of control.

Trying to tackle the net debt load, Big Lots announced a $340 million deal in May to sell and lease back the Apple Valley distribution center in California, the company's headquarters and company-owned stores. This would help a great deal in tackling the debt load, factoring in the anticipated $240 million net proceeds.

That is just part of the story, as the actual operating losses of $100 million per quarter are simply huge and show little imminent improvements. Comparable sales for the second quarter are seen down in the high-teens and while gross margins are expected to improve a bit on a sequential basis, losses are likely very substantial.

In July, Big Lots closed on the sale-and-lease-back transaction, but the gross proceeds came in a bit lighter at $318 million, likely due to the deteriorating operating performance of the business and headwind in real estate markets, causing some renegotiation on the headline price.

What Now?

With 29 million shares of Big Lots commanding a market value of about a quarter of a billion at $8 and change, it is clear that investors fear the worst for what still is a >$5 billion business. While net debt will fall to about $200 million pro forma for the real estate transaction, it will increase again following continued operating losses and the fact that the operating business will be hurt and impacted by higher lease expenses.

Furniture demand will likely be pressured in an inflationary environment, with housing sales under pressure and many consumers having shopped for new furniture during the pandemic times. Even as peers like Bed Bath & Beyond went bankrupt, that should provide an uplift, but might hurt near term sales as well following liquidation sales by bankrupt peers.

On the other side is room to cut inventory levels further (and improve cash flows that way) with operating expense cuts being announced as well. That being said, some real execution is needed and fast as the hole keep growing by the day. Given all this, I am a bit fearful of the situation at large here, seeing no reason to get involved on this battleground stock.

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