BIG - Big Lots: Is It A Buy Following Q2 Results?

2023-08-29 10:07:23 ET

Summary

• Discount retailer, Big Lots, reported Q2 results that came in much better than feared.
• Shares soared over 10% immediately following the release.
• Significant savings in SG&A costs as a result of their cost reduction and productivity initiatives contributed to a strong beat on earnings.
• Efforts to shore up liquidity also appear to have been viewed favorably by the markets.
• I believe BIG has more room to run, with shares still down significantly since Q1.

There is a lot of fear baked into Big Lots’ ( BIG ) stock price, perhaps rightfully so. It’s among the top ten shorted stocks by Wall Street. And earlier in the month, it was reported that the company was working with an advisor to improve its operating position.

In my last update on the stock, I wrote about the outlook after shares dropped to an all-time low following the release of their Q1 results. Shares were up about 4.5% since that update and prior to today’s print.

Results in Q2 reinforced my belief that the selloff in BIG has been overdone. Despite the post-print bump, the stock has still seen more than two-thirds of its value evaporate over the past year. It’s unlikely the company will recover all their losses. But I still believe too much fear is embedded into the stock at current trading levels.

BIG Stock Q2 Results

Total net sales were down 15.4% YOY, less bad than feared. The decline was driven in part by a lower store count compared to last year. On a comparable store basis, total net sales were down 14.6%.

Gross margins came in at 33%, down 40 basis points (“bps”) from last year and 190bps from last quarter. The SG&A rate improved from last quarter, at 40.1% of total revenues. This compares to 54.9% in Q1. The stronger savings from an SG&A perspective led to an adjusted EPS loss of $3.24/share, much better than the loss of $4.12/share that was expected heading into the print.

BIG also shored up their balance sheet by executing on a sale/leaseback transaction on its distribution center in California, as well as on 22 of their owned stores. This resulted in gross proceeds of +$300M or net of approximately +$294M. Since it occurred after the quarter end, it wasn’t reflected in their reported quarter-end liquidity total of +$258M.

Overall inventory balances were also lower by 15.2%. This follows an 18.8% decline in Q1.

Why Did BIG Stock Rise Following Results?

BIG’s performance was significantly less bad than feared. This was especially so at the bottom line, where BIG beat consensus estimates for adjusted EPS by $0.88/share. The beat was attributable in part to the successful execution of their cost reduction and productivity initiatives. The SG&A rate, for example, came in at just 40.1% of total revenues. That’s not that far off the 37.9% reported last year. And it’s significantly improved from the 54.9% rate in Q1.

Investors also appear to be cheering a more promising forward outlook. The selling environment is expected to improve. And margin recovery is expected to accelerate towards the back half of the year, aided in part by a more normalized promotional environment and lower freight costs.

The management team is also executing on their efforts to shore up liquidity. The recently completed sale/leaseback transaction, which brought in net proceeds of nearly +$300M is a prime example of this. A better overall inventory position is another.

What Is The Outlook For Big Lots?

While BIG didn’t provide EPS guidance for the third quarter, the outlook provided reflects a steadily improving operating environment. Comparable sales are expected to be down in the low-teen range. This would be an improvement over the mid-teens decline in Q2.

The biggest improvement is expected in the margins. Looking ahead, the management team is expecting accelerated recovery as a result of their cost reduction and productivity initiatives. A more normalized promotional environment and lower freight costs are also expected to provide tailwinds. The improvements should be seen as soon as Q3, where gross margins are expected to be 200bps improved from the same period last year. In addition, the SG&A rate is expected to be down a low-single digit percentage relative to 2022.

The momentum is then expected to carry into Q4, with comparable sales down in the high-single-digit range and gross margins in the high 30s.

Is BIG Stock A Buy, Sell, Or Hold?

I continue to view BIG as a “buy” following Q2 results. CEO, Bruce Thorn, did note that the company remains in a very challenging operating environment, where there is little appetite for higher-ticket discretionary purchases, especially among lower-income customers, their core base. This was reflected in results that showed sales down in the upper-teens percentage.

Though the environment is expected to remain challenging moving forward, it’s projected to be significantly less bad than feared. By Q4, sales are expected to be down in the upper-single-digit percentage range. That may not be grounds for the biggest celebration, but it’s a big improvement from the declines seen more recently.

The acceleration in margin recovery and improved liquidity position warrants a bullish view of the stock. By year-end, gross margins are expected to be in the upper 30% range. And the SG&A rate is expected to be lower beginning in Q3. These aren’t indicative of a company facing an existential threat.

Despite the post-release bump, I continue to believe excess fear is baked into the stock. In my last update, I noted that shares commanded an average multiple of 0.23x forward sales over the last five years. Today, shares trade at just a fraction of that, having lost over two thirds of their value over the past year. In my view, a price point in the mid-$15/share range still appears appropriate. For investors with greater risk tolerance, BIG remains one worth second consideration.

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