Description

Summary:  A simple idea, Big Lots is an asset play that should generate more than 700m in gross cash flow in the next three years with much of that free on a current enterprise value of 1578.  If successful with a modest expansion plan, gross cash flow generation should be even higher.  The market is currently focused on tepid comp performance and bleak near-term employment picture.  

Business.  Big Lots operates 1,345 retail variety stores catering to middle to low income customers.  Big Lots is known for deep discounted closeout merchandise in toys, consumables, furniture, electronics, office products, seasonal and other areas excluding apparel.  Average store size is 30k sqft.  Over the past few years a new CEO has led a renewed focus on the business (merchandise and inventory, real estate, and cost structure), with a halt to expansion, headquarters rationalization, elimination of certain SKUs (primarily apparel and frozen and chilled foods), higher inventory turnover, and generation of cash flow.  Store counts have remained in a tight 100 store range though the company has pruned real estate and is now looking at growing by 3 to 4% a year for the foreseeable future, helped by a better real estate market across the country.  The average store does about 3.4m in sales and about 158-160 per sq flt. 

Here's why I like the stock:

*solid balance sheet.  Q4 BS ended with 35m in cash and 62m in debt, with the Q1 BS showing 51m in net cash. 

*high free cash flow yield.  BIG generates 229m in trailing cash flow with an expected CapEx budget for 2009 of 85m (40m maintenance, 20m for 45 new stores, 20-25m for IT projects), or a 8.9% free cash flow yield (d/a is 70 to 75m) 

*active buyback plan (in the past).  In the past 5 years BIG has purchased 978m in stock, taking the share count from 116.7m in 2003 to 81.4m currently.  As have most companies, BIG suspended the buyback plan so free cash flow is currently accumulating on the balance sheet and one would suppose buybacks remain a logical option for the excess.  Options have been reasonable (about 1.5% issued per year though cancellations are very significant) and management compensation, excluding the CEO, is very reasonable. 

*a clear niche.  There are a ton of places to shop in this world but BIG distinguishes itself as the only truly multi-price point close-out centric public store chain that I'm aware of.  While the company considers mid to lower income as their target area, the true customer base is more lower income than most chains, and close-out merchandise has particular appeal to this group.  Plus, the company's rather unique store presentation - with furniture on one side of the the floor along with toothpaste and electronics and everything else in various locales besides creates a strong "treasure hunt" aspect to the shopping experience which encourages repeat visits. 

*low leverage point on SGA.  BIG has stated several times that they can lever a flat to slightly negative comp.

*modest expansion possibilities.  The company has stated that current infrastructure can support 1800 stores which one presumes means that the current DC network will not need significant expansion for several years. 

Here are some concerns:

*near-term stimulus comparisons.  Last years stimulus checks clearly had a favorable impact on business (comp +2.8% measured on a 2 year basis) so near term compares are tough, though if you fast forward six months from now the Q4 compare (-3.2%) is far more favorable.  Note that with BIG consumables, which have done so well for DLTR and FDO, only represent 30% of sales so there hasn't been as big an impact from this area.

*stock price volatility.  The stock price has undergone some extreme volatility in the past three years with regular $12 to upper 20s mid 30s trips as investors react to the fate of same store sales.  Earnings performance, however, has been steady and investors can catch this stock for an even cheaper valuation if the past is any indication.  I simply feel that the current price is a logical entry point for a full position in a diversified portfolio.

*Peak Margins.  BIG did achieve the highest net margin of its past 10 years last year, though I believe that the changes current management has made to this business model will allow current margins to stick rather than revert to previous levels. 

*Furniture.  Ready to assemble and mattress make up 15% of sales and this area is uniquely exposed as a discretionary category, though note that at least in Q1 furniture sales were favorable and there is a market for this type of merchandise.

Bottom line:  I think BIG is being valued far cheaply for a retailer with a clear niche and tremendous cash flow generating ability.  Even if cash flow remains flat, this should be a successful investment.

Catalyst

1 - resumption of buyback plan

2- any improvement in comps

3 - end of recession mindset that solid companies should be valued at 10x