Thursday, October 6, 2011

Big Lots (BIG:NYSE)

This is a write up I did a few weeks back and I think it is still very relevant. If you are interested to discuss more in detail, feel free to drop me a note to my email or to my blog inbox.

The firm was at market cap of $2.4 billion at around $32 per share. While I do not think it is likely to be a mega blockbuster within a short time frame, it does have the qualities and price levels that a private business owner will be interested in. A better valuation will be more ideal. 
1) Company Background
  • Brief overview
    • Big Lots (BIG) is a US’s largest closeout and overstock retailer (i.e buys surplus inventory, odd lots
    • The firm has 5 distribution centers, 1405 stores in 48 states, 41.925 million sf. (April 2011)
    • Stores mainly in Texas, Florida, Ohio, Pennsylvania and California
    • Distribution centers in Ohio, California, Alabama, Oklahoma, Pennsylvania total 9.5 million sf (All owned except 0.45 million sf leased in Ohio)
  • Operations
    • Company basically contacts vendors who have surplus productions, shutting down operations or businesses and purchases goods in bulk at discounts and retails them at a slight markup
    • Some merchandise not available through closeout and imported (20-30% of sales)
    • Mainly in Seasonal and furniture and to lesser extent toys and home department
  • Segments
    • Company products on retail to both individuals, families and wholesale to corporate (% of sales 2010)
    • Consumables (food, health and beauty, plastics, paper, chemical, and pet stuff)  - 29.3%
    • Home (domestics, stationery, and home decorative) – 15.8%
    • Furniture (upholstery, mattresses, ready-to-assemble, and case goods) – 16.8%
    • Hardlines (electronics, appliances, tools) – 14.1%
    • Seasonal (lawn and garden, Christmas, summer) – 13%
    • Others (toy, jewelry, infant accessories, and apparel) – 11%
  • Other corporate information
    • Hit $50 in 1997, $30-40 range in 1999,2007,2008 and recent high >$40 in 2010 and 2011
    • At current price of $32.23 per share on 75.19 million shares gives a cap of $2.42 billion
    • Owners are CEO Steven Fishman 1.3%, Wellington Co 7.1%, Sasco Capital 6.6%, Vanguard Group 6.1% and LSV Asset Mgmt at 5.2%. Directors and executives (21 pax) owns total 3.3%.
2) Investment Thesis
  • Business
    • Resilient business – people like deals regardless of good or bad times
    • With bad economy and people less willing to spend, Big lots is clearly a beneficiary
    • Such a boring business that no large bulge bank covers it
    • Open to buy in excess of $3 billion for inventory liquidators – few can match that
    • Firm has never had a negative year of same store sales
  • Moat/Competition
    • Largest in this field of closeout and overstock and no other close comparables
    • Moat lies in the network of negotiation and distributions of products, clearly being large and having a strong  network is the key advantage which few can replicate
    • No one is able to offer a lower price than Big Lots, not even the dollar stores or dollar tree stores
  • Operations, margins
    • Thin margins as gross margins is around 40% and selling and administrative expense is about 31-32% with depreciation only at 1.5-2% range. Margins remains higher than peers
    • Firm focus on cost led to decline of overall cost from 38.5% to 33.4% from 2005 to 2010
  • Management
    • 2010, executives are awarded about 80% in non equity incentive compensation based on corporate performance benchmarks, total $22.8 million among 5 executives ofwhich average is 1/5 in options, 1/5 in non equity incentive, 1/3 in stock and rest in cash
    • 8 directors compensation is around $1.5 million, about 50-50 in stock and cash
    • CEO Steven Fishman has experience in bankruptcies and turnarounds (Rhodes Inc 2004)
    • Has a knack for deals as shown by intelligent acquisitions of competitors, recent by liquidators world based in Canada and sale of old toys department to Bain capital
    • Open to sale of firm, recently rejected bids by 2 consortiums of ThomasH Lee+Advent , TPG+Bain advised by Goldman Sachs in 18 May. Analyst estimates bids at $3-3.5b while research houses value the firm at $4b. Management is also clear on the firm value. 
  • Situational
    • Firm rejected PE buyers' bid and below estimates earnings resulting in sharp drop in stock price of 27+%
    • Firm intends to expand beyond US evident from purchase of Canda’s Liquidation world

3) Financials (assumptions) - All figures in USD millions (unless otherwise stated)

    • Firm is net cash $178 million and employs 0 leverage
    • Shareholder equity decline in due of the massive share buyback which resulted in approximately $1 billion in treasury stock versus $1.5 billion in retained earnings and $0.52 billion of paid in capital (shows the financial power of this firm)
 4) Risks
    • No dividends - but the firm has massive stock buyback programs, latest being $400 million worth
    • Irregularity to consistency of range of products sold - led to recent gap of food products and same store sales
    • Inaccurate expectation of demand may lead to poorer sales and inventory clearing or markdown
    • Bigger, financially stronger retailers may enter their field - deep network expertise needed
    • Energy prices affect transport from vendor to Big lot’s distribution center to Big lot shops
    • Sourced 25% of goods overseas, notably 21% from China so theres fx risks - Yuan capped
    • All stores except 54 (Mainly in California) are leased - but distribution centre owned 
    • On average 250 leases will expire annually from 2011 to 2015.
    • Slowdown in top line (although management has been able to squeeze higher profits) - attractive valuations 
    • Alignment of interest could be better since insiders only own 3.3% of total shares out

5) Expectations - figures in USD millions (unless otherwise stated)
    •  KKR paid 11x EBITDA for Dollar Stores LBO back in 2007
    • Averaged firms trade at 10-11x EV / EBIT
    • If the discount rate is 10%, expected return is still positive at 3.9%
    • If the long term growth is 0% / -2%, returns are still 29.6% / 3.4%
    • A value of $3-3.6 billion is fair but I opine that upside could be much larger
    • Reason being theres a lot of room for improvement, PE firms interest, strong organic growth and financial strength
    • Valuation accounts by using the perpetuity formula as mentioned in John Burr's "Theory of investment value"
    • If one uses a stepped FCF valuation, be it 5 or 3 years, the valuation will be higher
    • Long term growth at 1% based on past growth and should not outgrow US economy growth
    • Discount rate is 30 year treasuries at 4.20%, bumped it to 7% for risk premium. Higher discount does not equate to negation of risks, it is purely a measurement tool  
Sources: Google, Wall street Journal, Big Lots webpage, SEC filings and Annual reports