Featured Idea: Long on Big Lots (NYSE: BIG)

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Adib Motiwala
Source: Motiwala Capital. Dallas, TX.

Recommendation: Long Big Lots (NYSE: BIG)
Timeframe: 2 Years and Beyond
Recent Price: $35.66
Target Price: $52.00

Quick Thesis
Big Lots, Inc., (NYSE: BIG) a Fortune 500 company headquartered in Ohio, is the North America’s largest broadline closeout retailer. Closeout merchandise generally results from production overruns, packaging changes, discontinued products, liquidations, bankruptcies, returns, and other disruptions in the supply chain of manufacturers. As a result, BIG can generally purchase and offer closeout merchandise at lower prices than would be paid by traditional discount retailers. In addition to closeout merchandise, BIG stocks many products on a consistent basis at their stores that they believe provide great value to their customers.

Gross margins have been more or less stable around the 40% mark. However, Op margin has improved from 3.9% in FY 2006 to 7.2% in FY 2010 driving the ROE increase from 10% to 23% from FY 2006 to 2011.

For FY 2010 (ending 1/29/2011), BIG had invested capital of about $1 billion. On that invested capital, BIG generated a pre-tax operating income of $357 million for a 35% pre-tax ROIC. That is simply superb. The best part is the improvement in ROIC over the last five years from 16% in 2006 to 32% in 2011.

Store count actually went down from FY 2006 to FY 2008 as the company focused on improving profitability of the existing store base. Also, due to the economic boom/bubble in 2006-07), lease/ rental rates were not favorable. As a result, management closed more stores in those years. From FY 2009 onwards, as the real estate market hit a rough patch, management was smart to renegotiate leases that were coming up and in fact opened more stores than they closed. BIG intends to open net 45 new stores in 2012.

On 23rd April 2012, Big Lots updated guidance for retail sales in Q1 2012. BIG expects SSS to be slightly negative compared to prior guidance issued on March 2, 2012 which estimated SSS increase of 2% to 4%. The weakness was in consumables and electronics which were below expectations. Mr. Market slammed the stock 25% on this announcement.

At the current price of $37.5 and TTM EPS of $3, BIG is trading at a P/E of 12.5. BIG has a market cap and enterprise value of $2500 million. Using FY 2011 EBIT of $346 million, I get EV/EBIT multiple of 7.2. OCF has averaged $340 million for the past three years. BIG is trading at 7.6x average OCF.

With Sales of $5200 million, EV/Sales is 0.5x. In the 2010 10-K, it was indicated that $50 million was the growth capex for 90 new stores. Using $80m of the total $130m guided capex as mcapex gives us MFCF of $250 million and BIG is trading at 10x MFCF. Management guided to 2012 EPS of $3.5. Using this guidance, BIG trades at 10.7x forward P/E.

Comparing to the dollar store companies that are the closes comps, one can see they are trading for much higher valuations:
Family Dollar (NYSE: FDO): 20x P/E, 0.9x EV/Sales, 16x EV/OCF
Dollar Tree: (Nasdaq: DLTR): 25x P/E, 1.8x EV/Sales, 17x EV/OCF
Dollar General (NYSE: DG): 21x P/E, 1.3x EV/Sales, 19x EV/OCF
Big Lots (NYSE: BIG): 12x P/E, 0.5x EV/Sales, 8x EV/OCF

99 Cents Only Stores NDN agreed to sell itself to Ares Management LLC and Canada Pension Plan Investment Board for $22 a share, in a transaction valued at about $1.6 billion. The multiples paid for the transaction were as follows: P/S = 1.1x, EV/EBITDA = 9x, EV/EBIT = 11x, P/E = 20x. If BIG were to be acquired for 10x EBIT, it would be valued at $3400 million ($54 a share using 63 million shares).

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