BIG - Big Lots: Short-Term Value Play Not A Compounder

Summary

• BIG was a beneficiary of Covid spending, but things have normalized a bit now.
• They reduce share count meaningfully, but right now, the business is unprofitable and has growing debt levels.
• Shares are cheap on a relative and intrinsic basis, but this comes with a caveat.

Big Lots (BIG) is a discount retailer that has 1,457 stores across 47 states. The easiest way to describe BIG would be a slightly bigger dollar store that sells furniture. They’ve had consistently higher gross margins than many other discount retailers. The customer experience is built on discounted goods and the thrill of the hunt for finding a random deal. There isn't much standardization as far as inventory goes, so customers expect a different experience every time they shop.

The business model isn’t very compatible with e-commerce. With the wide variety and discounted nature of their goods, it will be hard for BIG to make any meaningful profits from e-commerce, so it makes up a small part of total revenue.

Below is the long-term share price performance:

Next is the return on capital metrics compared with peers:

*8 years

While the return on capital numbers look impressive at first glance, this hasn’t been a classic compounder stock at all.

They were a big beneficiary of Covid related spending which results in revenue and earnings, and returns on capital all peaking in 2021. Now that things have normalized a bit from that point, margins are back to typical levels.

Capital Allocation

I’m a big fan of companies that successfully employ the “cannibal" strategy as far as being consistent net buyers of shares. There are some shining examples where this strategy was pulled off brilliantly. NVR and AZO are a couple of prime examples in this category but there are others that haven’t had near the same results.

This is because simply reducing share count on a regular basis is only part of the equation. There are more scenarios where regular buybacks won’t work than will work. If the top line is seriously contracting, or earnings are inconsistent then the cannibal strategy won’t work. Also if debt levels rise while repurchases are made, this can end up being a mistake.

Buybacks only make sense when all the reinvestment needs have been taken care of. This is a reason why they are so prevalent with retailers. The only types of reinvestment are basically opening new stores or acquisitions. When enough shares are repurchased, EPS and FCF/share should mathematically increase even if earnings and free cash itself stays completely flat. [[IBM]] is a case where share count is being reduced as business shrinks, and this is what you want to avoid.

So with BIG, we do have a long track record of share count reduction. Repurchases became a regular action starting in 2005, and share count is down 73% since then. The problem is that revenue grows very slowly over the long run, store count is not increasing, yet debt levels are increasing.

Cash flows aren’t so erratic that the business could be considered cyclical, but there isn’t quite enough consistency for this to be an effective “cannibal” stock.

The capital allocation should be straightforward with BIG. They have long reached the peak of store count, and they don’t make acquisitions. So a strategy of consistently cannibalizing shares should work so long as free cash flow is stable and debt levels don’t get out of hand. They began paying a dividend in 2015 and the current yield is 7.1%.

Risk

I don’t think they will remain unprofitable for a long time. The biggest risk is that the price is presenting a value trap right now. Debt is a bit too high for my liking, but I don’t see that being the thing that would sink them. The business will be ok in the long run, but the size of the business doesn’t have much room to grow aside from acquisitions.

Valuation

BIG was pushed to all time highs in 2021, like so many others and was no doubt overvalued at that point. Now that things have cooled off, share price is down 75% since 2021, does this mean the stock is undervalued now? Shares are around the same price as the 2020 Covid lows.

Source

So long as the dividend isn’t at risk of being cut, the yield right now is a very good spot to get in at.

When it comes to multiples and the dividend yield, the stock looks cheap. Next is the DCF mode using 2019 EPS to normalize:

So on a multiples and intrinsic basis, I do see the company being undervalued with the dividend acting as a decent margin of safety. There is an important caveat though, and it is that this company is not a compounder. The size of the business won’t increase decade after decade, and intrinsic value won’t increase over time. This means it's a value opportunity that pays a pretty nice dividend to wait for a bit of re-rating once profitability returns.

Conclusion

Big Lots was a winner during Covid due to it being a popular place for people to spend stimulus money to upgrade their homes relatively cheaply. Share prices peaked in 2021 like so many others, but now the stock has been a bit unfairly punished in my view. Shares are discounted on a multiples and intrinsic basis, but the concern I have is that this is not the kind of long-term compounder I like to hold. This stock is for the shorter-term value investor who can get in at the right spot.

For further details see: