Opened Position in Big Lots (Ticker: BIG)
I bought this on the day the Dow Jones went down 724 points. This is my second time owning Big Lots. I bought in 2011 on separate occasions and earned 21 percent and 9 percent respectively. I kept it on my wish list since because I felt that the discount retail space is a growing one given the hollowing out of the middle class and polarization between high and low income consumers. I never bought back in as the stock really took off and I just thought it became too expensive for my liking. In the last while the stock had been pulling back down from the $60’s to its current level in the low to mid $40’s, which caught my attention so I decided to dive in and take a look at it. Like always my dive into Big Lots involved answering those pesky but important 8 questions.
Question 1: What do they sell? What is their value proposition?
Big Lots is a US discount retailer, but a little different than other retailers in that in their original form they scoured the land for products that have been discontinued but are still useful or products where the vendor perhaps made too much inventory and are looking to clear out. They buy these “Lots” of goods, often for at a sizeable discount which allows them to sell them at very competitive prices and generate a profit. You’re not going to find a lot of brand names at a Big Lots. We’re talking second or third tier quality goods. Functional and usable. The company still follows this format but has evolved into sourcing products more traditionally and also has expanded into food offerings. The company is also fitting up its stores with refrigeration and freezers to offer more diverse food offerings.
Question 2: Who do they compete with?
The discounted retail space is a crowded space with numerous competitiors such as Walmart, Target, Dollarama, Giant Tiger, Dollar General, and Dollar Tree. We also can’t forget Amazon. It’s a very low margin industry.
Question 3: Who buys their products?
Big Lots caters to the lower-income demographic that is very price conscious. They are also very sensitive to changes in their living costs such as rent, utilities, and food. So when gas prices spiked up, it impacted Big Lot’s customers.
Question 4: Will they come back again and again?
Big Lot’s focus on sourcing goods at low cost so they can charge competitive prices is attractive to low income consumers looking for maximimze their dollar so they do come back frequently.
Question 5: Do they make money?
What attracted me to Big Lots in the past was their ability to generate consistent Economic Profit. It appears that they have not missed a beat with respect to creating solid financial performance. Over the past 3 years, Big Lot’s return on invested capital has ranged between 18 to 26 percent which is much higher than their cost of capital of 10 percent. This company continues to generate tangible wealth. Their streak of consecutive quarters of break-even or higher profit was recently snapped (it may be a reason the stock is slumping?). The quantity of earnings may not be in the league of Walmart or Target but its quality of earnings are quite strong. Revenue growth has also lagged competitors and is in the low single-digits. It’s not a growth story stock here.
Questions 6: What do they own and who do they own money to?
Big Lots has something that is very rare and that is a clean, simple balance sheet. Not a lot of funny stuff. From a liquidity perspective their ratio of current assets to current liabilities (Current Ratio ) is over 1.5 which tells me they have more than enough liquidity to sustain their day-to-day operations. What maybe a bit concerning is they carry a fair bit of inventory. Remember they source a lot of goods that are discontinued or in excess supply so they have to hold higher inventory because they can’t send it back. The company seems to manage through this though. From a debt perspective, the company has a manageable amount of debt. Its debt/equity ratio comes in at 0.30. They have no intangible assets so the quality of their assets is high. The company’s financial position appears to be quite strong. It isn’t going out of business anytime soon.
Question 7: How risky is the business?
Big Lot’s customers are in the low-income bracket and as a result, are more sensitive to changes in the economy, having said that, they value low cost and Big Lots provides them that access to goods. First level thinking would suggest that online retail lead by Amazon and Walmart would be a serious threat, however I would think that their core customers don’t have steady access to online resources. Many may not even have a smartphone. As a result, I would think they would gravitate to low cost retailers like a Big Lots. I’m thinking a retailer like Big Lots would actually be more insulated against the ongoing disruption of the retail space.
Question 8: Is the stock cheap?
The stock is right now cheap relative to other discount retailers. Their forward P/E multiple is 9.5 which is much lower than similar companies. From a valuation perspective the stock is valued in the $41-60 range. The stock was fairly priced up until January where it then has been falling down to the mid $40’s. The stock appears to be out of favour.
One of my investment themes I have been integrating where possible in my portfolios involves investing in the extreme ends of retail, which is luxury retail and discounted retail. Our society (good or bad) is evolving into extreme classes, skewing more to high and low income. That middle ground is becoming harder and harder to exist. To get exposure to this evolution, I’ve always kept my open for opportunities in the luxury and discount retailers. Big Lots has made a bit of differentiation and done a nice job of servicing the low-income market. Management continues to deliver solid Economic Profit and appears to be continuing to practice prudent fiscal discipline. The threats are real and out there, but I think given the demographic it is catering to is out of that zone and so the firm might have some protection from the retail disruptors. Given the pullback in the stock and its continued solid wealth creation, I thought this would be a good opportunity to get in, so I decided to open up a small position and build it up should the market continue to pull back.