The Oxen Report: Long Term Investment Opportunity and Company Investigation – Big Lots

Profile: As of the beginning of 2009, the company operated 1,339 stores in 47 states. The company operates as the largest broad line closeout retailer in the USA. Big Lots offers products in the food, health and beauty, plastics, paper, chemical, pet supplies, home decorative, furniture, electronic, tools, home maintenance, seasonal, toys, infant accessories, and apparel lines. The company is headquartered in Columbus, Ohio.

 

 

 

With the economic downturn and new management in 2005, Big Lots over the past several years has begun to gain market share, increase profitability, and carve out its own niche in the discount store market. The shopping center has seen an influx in its income and free cash flows, which has begun to attract investors to the company. As of recent, the stock has increased at rapid rates with successful quarters. The question for Big Lots, though, is whether or not the company can keep it going. The company has been able to produce consistency in its revenues since Steven S. Fishman took over as CEO and President in 2005, which was rather non-existent prior to his arrival. Additionally, the company has redefined its business, focusing on developing new markets with higher-income residents and smaller stores, increasing its brand name during the economic downturn, and focusing on long term growth by increasing efficiency and margins.

 

The company, though, does face rigorous competition from three sides. It loses market share from the smaller, dollar-store competition, seen in Family Dollar, Dollar Tree, and Dollar General. It faces competition from wholesalers that offer discounted groceries and other goods in Costco and BJ’s Wholesale. Finally, the mega-stores of Wal-Mart and Target steal a sizable market share. Yet, Big Lots has been able to maintain a small niche in this market because it does not fit into any of these categories. It is larger in size than the small, convenience store style of the dollar stores. It is not as large or offering groceries like the wholesalers, and Big Lots is much smaller than the overwhelming Target and Wal-Mart. The economic moat is very small, but it does appear that Big Lots has somewhat of a niche in the market as a senior dollar store but a junior Wal-Mart. The company, specializing in closeout offers goods that other retailers were not able to sell or kept in inventory for too long. They are the leader in this industry, but their product and price lines are consistent with these three sectors.

 

Big Lots, because of the economic crisis, has been able to grow a consumer base that it did not have prior to 2007 and is developing itself with new stores. As long as the popularity and necessity of budget-conscious consumers remains, Big Lots should continue to see an increasing market, increases in sales, and increases in the value of its shares. The chain’s main positioning mechanism, during this time has been the development of both smaller stores that are considerably smaller than current stores and its move into higher-income markets. The company, in 2009 for the first time, opened more stores than it closed due to its ability to expand, increase in free cash flows, and demand. The company opened 52 new stores in ’09 and is planning to open eighty new stores in 2010 and 100 in 2011 and 2012. The move into higher-income homes may be the most beneficial part of Big Lots’ plans for development. Big Lots entered “A” rating locations, which refers to high-income retail areas. Inexpensive commercial real estate allowed the discount store to open eight new stores in the “A” rated areas, and they plan to continue that development with 24 more in 2010.

 

The company, additionally, has been redefining their business structure in order to increase their operating margins. On a ten-year average, the company had margins of 3.16% and ROA of 2.14%. In looking at just the past five years, the company has turned their margins into 3.24% and return on assets into 5.74%. The company has been able to decrease expenses as companies have continued to have excess inventory and lower prices. The company stresses it has remained profitable with tight inventory management and offering assortments of goods that consumers want. The company’s efficiency results reflect such claims as the company has improved its inventory turnover significantly. The ten-year average is 3.03 times per year versus a five-year average of 3.44.

 

Competition, however, still remains very tight in the industry. The company will have to continue to improve inventory management, understand trends in what consumers want to buy, offer the right assortment of goods, and continue to improve its efficiency. Discount retailers, however, all have their sights set on expansion in the economy, and they will continue to crowd the market. While Big Lots has taken many of the right steps to begin to carve out a small niche and expand into new markets that will benefit the company significantly, the improvement of the economy, the lack of long-term consistency, and competition present significant challenges to Big Lots. The size of its stores and diversity of goods it offers, however, will continue to set it apart from other discount retailers. As the company enters new markets, they are gaining brand name in these areas that will help to continue their successes post-recession.

 

 

My fair value estimate for Big Lots is $33.14 per share based on the attached discounted cash-flow analysis. The company

has seen incredible growth in its operating income in the past five years, averaging over 96% year-over-year. While these growth rates cannot be maintained long term, the company should be able to see continued growth on its operating income of 8% over the next five years. Given the development of new stores and new markets, the continuation of the economic downturn, and continued growth of same-store sales that was 0.7% in 2009, the company should continue high single-digit growth in its income. The company is estimating operating cash flows of nearly $200 million in 2010. I have started my estimated available cash flows lower at $160 million to help remain cautious in an emerging company that may be setting the bar too high on too few consistent years. With questions on competition, however, and a post-recession economy, 8% is a modest assessment that is including a significant amount of caution, considering a maximum bear case. Operating margins should continue to be in the low-single digit range over the next five years. The company continues to increase its efficiency but continued competition and upturn of the economy will keep these in check.

 

 

Risk is definitely high with Big Lots. The company, in the last five years, has started to truly redevelop and reinvent itself. New CEO Fishman has kept the company moving in the right direction with a long-term growth development plan, but competition remains very high. The company’s economic moat is not significant, as well. Additionally, low-income consumers have less consistency in purchases than high-income consumers. The movement into new, “A” grade markets does help hedge some of this risk, but the company still has the majority of its operations with low-income families. Upturn in the economy, decline in unemployment, and continued price slashing at other retailers will continue to threaten Big Lots’ recent success.

 

 

CEO Steve Fishman has done some very admirable work with this company. A retail industry veteran, who has thirty years experience as former CEO of three companies, Rhodes Furniture, Frank’s Nursery & Crafts and Pamida, that he successfully restructured and helped bring into profitability. His experience in restructuring has helped Big Lots thus far. One issue, though, with management is that with the recent success the company has experienced, Fishman and other executives has seen significant increases in pay. Executive compensation grew from $8.74 million to $15.71 million from 2006 to 2008. The pay is in line with competitors, but the growth is still something to keep in mind. Further, Fishman has seen a tripling of his compensation package since 2006. Additionally, it would be better if there was a split of the chairman and CEO position that Fishman currently holds. The board is independent.

 

 

Growth: The company has averaged 90% increases in its operating income in the past five years and over 40% in the past ten years. These results, however, have been very erratic. The company should settle into a high-single digit operating income growth rate as it continues to grow revenue and decrease expenses.

 

Profitability: The company should continue to maintain its operating margins in the 3-4% range. The company is facing continued competition and will see increases in commercial real estate prices. Gains should be made, though, by the introduction into higher income areas.

Financial Health: The company is in very solid financial condition. The company has increased free cash flows, no long-term debt, and a solid current ratio. The company does have some worry that its quick ratio is averaged at 0.25 over the past five years. The company has a very solid interest coverage ratio with EBIT 50 times interest expense in 2009.