Description

BIG: Recent sale-leaseback (SLB) proceeds plus FY21 cashflows create the stock at ~2.2x normalized EBITDA. Valuation fails to appreciate BIG’s fortress balance sheet, recession/COVID-resistant positioning, and unprecedented closeout opportunity. We see ~125% upside, ~60% base case return, and 15% plausible downside.

Company overview

Big Lots (BIG) is a domestic hardline discount retailer with ~1,400 stores across 47 states. BIG’s primary categories are Food & consumables (~29%) Furniture (~27%), Soft/hard home goods (~23%), Seasonal (~15%), and Electronics, Toys, Other (~6%). BIG’s roots are in the “closeout” business, which historically accounted for ~50% sales through 2014 but has declined to ~10% of Sales by 2019. “Closeouts” are typically brand-name merchandise which “is generally sourced from production overruns, packaging changes, discontinued products, order cancellations, liquidations, returns, and other disruptions in the supply chain of manufacturers” (10K). Closeouts are typically purchased for pennies on the dollar and offered to BIG’s customers for up to 40% discounts while still generating above average merchandise margins in their categories.

Thesis

BIG’s recent ~3x appreciation from March lows and ~18% appreciation YTD have disguised that, at current levels, its SLB transaction, along with strong FY21 performance are poised to create the stock at 1.9x – 3.0x FY22 EBITDA. Downside is protected by BIG’s fortress balance sheet (post SLB), valuation, and relative insulation from macro risks. Meanwhile, a ~60% return is likely merely from a return to “normalized” performance, and ~125% or more upside exists if BIG succeeds in its stated goal to harness this year’s impending closeout tsunami.

What happened since Q1 and what it means for enterprise value

On June 16^th, BIG announced the closing of its SLB transaction, generating $550M in proceeds. Concurrently, BIG announced that it paid off its entire outstanding revolver balance immediately prior to close. This paydown implies that BIG generated at least $78M of net cash between the end of Q1 and June 16^th. We assume that BIG will generate another ~$70M of cash between June 16^th and the end of FY21. We expect this assumption is conservative because it implies a top line deceleration far more precipitous than we are currently seeing in our transactional and geolocation data ensemble. This assumption also implies that in a year benefitted by COVID and stimulus tailwinds, BIG will generate ~$20M less cash than its trailing 5-year annual average. At current market cap, this implies an EV of ~$762M by year-end. This EV equates to 2.2x our “Normalization” scenario FY22 EBITDA. This EV also equates to 1.9x/2.5x the highest/lowest SLB-adjusted that EBITDA BIG has produced over the past ten years (FY12/FY14 respectively). See illustrations below:

Sizing the downside

After applying the EV math above, we struggle to see a reasonable downside scenario of more than ~15%, which represents 2.25x our FY22 Downside scenario EBITDA. We believe this downside is protected due to BIG’s historically low valuation, fortress balance sheet, and resistance to COVID/macro downsides:

Historically low valuation

BIG has been a justifiably ‘cheap’ stock for at least a couple of years because its comps, margins, and EBITDA growth have not kept up with higher flying peers. However, its valuation gap to peers, own history, and perhaps common sense has grown to overly punitive levels after adjusting for the SLB and FY21 as we do above. Despite its appealing balance sheet, recession/COVID-resistant characteristics, and strong current trends, BIG’s valuation gap versus comparables (many of which face greater near-term macro risks) has ballooned to more than twice its 5-year average. While peers trade at a ~6% premium on FY22 EBITDA consensus relative to their 5-year average valuations, BIG trades at a ~58% discount on our base case FY22 number. No doubt, some of the peers in the comp table below will also benefit from elevated FY21 cashflows, but their multiples are so high, and the valuation gap is so extreme that the difference should be minimal. Although BIG has no perfect compares, it shares something in common with discount, home, and furniture chains, which is how we chose the comp set below. Regardless of how we weight these comp categories the takeaway is always the same.

Fortress balance sheet

BIG should end FY21 with ~$620M of cash against ~$54M of debt (as illustrated above). Net cash of ~$566M (excl. buybacks) would represent ~43% of current market capitalization. The vast majority of this net cash (~$518M) will already be in place by the end of Q2. BIG is poised to report not only the best balance sheet within its peer group, but also one of the best balance sheets within the entire retail sector. See Net Debt as % of Market Cap above.

Resistant to macro risks: Most retail stocks are pricing in a V-shaped recovery, but the next few months could put the lie to that assumption. BIG’s relative resistance to the biggest macro risks limits downside on both an absolute basis and relative to the broader retail universe:

-          Prolonged recession

o   BIG comped positively and grew EBITDA during both ‘08 & ‘09 because it is a hard discount retailer with an average ~11% price advantage versus WMT/AMZN prices (see Appendix). While it may not be entirely recession proof, it is certainly more resistant than the vast majority of the retail landscape.  

-          COVID strikes back

o   BIG is an ‘essential’ retailer and already has experience running stores during shutdowns. COVID cases are again rising exponentially in several states, especially those which were lax in locking down (e.g. Florida, Arizona, etc.). Apple recently announced the re-closure of its Florida stores. China had to re-close many public venues in May as a 2^nd wave began. Texas announced a reopening pause today. Nobody knows whether COVID will re-emerge in force this fall or how that would impact the economy and consumer spending patterns.

Sizing the upside

Modest assumptions imply ~60% base case return

We see a ~60% return by assuming dramatic deceleration in operating trends from current levels, a return to “normal” in FY22 with no closeout benefit, and an intentionally conservative multiple.  See “Normalization” scenario in Valuation framework. If you wonder whether FY22 “Normalization” is reasonable to assume, we submit that despite questionable strategic choices over the past ten years, BIG’s comp and EBITDA performance have been reasonably consistent (refer to 10-year trailing comp and EBITDA chart above).

~125% upside scenario driven by closeout sales and margin opportunity

BIG was by far the largest closeout retailer in the country through 2014, with nearly 50% of sales coming from closeouts. BIG abandoned this dominant position to create a more planned assortment to pursue more consistent comp growth. Closeouts represent ~10% of sales today, which means BIG abandoned ~$2B per year of closeout sales. It is no coincidence that OLLI, and its ~$7B valuation, have been built upon taking advantage of the sales Big Lots abandoned. As the country enters the best closeout deal environment in living memory, we believe BIG is poised to benefit over the coming year and potentially permanently. No other retailer in the country has the scale, experience, and consumer positioning in hardline closeouts to gain as much incremental advantage from the coming closeout tsunami.

-          The closeout opportunity over the next 6-9 months is potentially massive

o   Excerpts from OLLI’s Q1 earnings call below illustrate this point. OLLI plays in the same closeout categories that BIG has an opportunity to get back into, but ~70% of OLLI’s sales already come from closeouts and it has only ~350 locations, so OLLI’s ability to absorb incremental closeout volume is limited.

§  Closeout opportunity size: “this is probably something we've never experienced since '08-'09. I think this is going to be something even larger than that. And there is going be a lot more opportunities out there and they probably going to be a little more immediate than what we saw between '08-'09.”

§  Closeout competitive landscape: “I think the opportunity is so big, it's not going to matter. And I think a lot of people do talk about getting into the closeout business. But as we always said, that's, it's not that easy just decide to become a closeout retailer and deal closeout product … I think the pie is going to be so big that there'll be enough for us to go around and be able to be fine here.”

§  Closeout timing: “sometimes it takes a little bit of time to manifest itself and become available because the manufacturer has to take little bit of pain and have some time with that product in order to get to our pricing level. So I would say we expect to see that in the next three to six months at the outside maybe nine-months that we'll start to see a little more -- a little bit more on the deal flow that becomes true closeouts … We are starting to see some of these already.”

-          BIG has the ability and intent to take advantage of this opportunity

o   BIG’s recent public comments along with our recent conversations with management have convinced us that BIG is aggressively pursuing the closeout opportunity and are uniquely positioned to take advantage of it. Quotes from BIG’s Q1 earnings call below:

§  “I wish I could tell you the details of the closeout deals that we have secured so far. I really want to tell you that … but I don't want to give away our secrets so to speak, but we're excited about the value.”

§  “We've really opened up a lot of open to buy for us to go after closeouts in this unprecedented environment with really quality closeouts that are out there … it will start to see on a weekly basis actually now really great quality closeouts hitting our stores. The team is being very aggressive. We've gone out after current vendors, new vendors and we've had many vendors that are coming forward to us because of some of their retailers that have either were closed or experiencing difficulty in their sales demand.”

§  “We're seeing opportunities across all of the categories that we traditionally do business with, first and foremost. So whether it's Furniture, Soft Home, Hard home, Electronics, so we're really going to see incredible deals across the business, but we're also very much open for what we call white space opportunities”

BIG’s pivot toward closeouts may be more than just a flash in the pan

o   We believe that it was a mistake for BIG to abandon its dominant position in closeouts and infer that the two recent activists in the company agree. We are further encouraged by the recent addition of Thomas Kingsbury, the ex-CEO of BURL to the board. We do not underwrite or model BIG permanently mixing back toward closeouts but consider it worth monitoring closely. OLLI’s ~$6.7B market cap (>5x BIG’s valuation) at less than 30% of BIG’s sales suggests that BIG could benefit significantly by edging back towards its roots.

Valuation framework

In our simple valuation framework, we make conservative FY21 cashflow assumptions to imply year-end EV. We then apply conservative multiples to our FY22 EBITDA scenarios (which we assume are reasonable proxies for post-COVID run-rate EBITDA).

Project FY21 year-end EV

-          As referenced above, we project ~$70M of incremental cashflow in FY21 after June 16^th based on the following operating assumptions:

o   2Q comps >20% (conservative according what we are seeing so far in our data ensemble)

o   Back half comps decelerate to +LSD despite easing compares

o   GM: Slightly positive YoY in 2Q; flat YoY in 2H

o   SG&A: 2.5% YoY organic growth + $42M annualized SLB rent expense (implied from Q1 earnings call)

Sensitize valuation by applying conservative multiples to plausible FY22 scenarios:

-          Normalization scenario: ~60% upside

o   BIG generates its 10yr average SLB-adjusted EBITDA of ~345M in FY22 and trades for 4.5x 1yr Fwd (15% discount vs. 5yr average multiple). We believe this is a reasonable base case because BIG has demonstrated consistent EBITDA performance over the past ten years through various macro environments and levels of same store sales. This case is equivalent to assuming EBITDA is ~15% below average and applying the average 5.3x multiple.

-          Downside scenario: ~15% downside

o   BIG generates ~$250M SLB-adjusted EBITDA in FY22 (~$50M below trough EBITDA experienced during its relatively stable 10-year range) and trades for 2.25x. Note that this would represent an annual EBITDA decline rate which has occurred only once in the past 15 years, and we are applying an almost ridiculous multiple, which BIG touched for a couple of days during its March lows (see TEV/Fwd EBITDA chart below)

-          Closeout upside scenario: ~125% upside

o   BIG generates its 10-year peak SLB-adjusted EBITDA of ~404M and trades for 6.0x 1y Fwd (13% premium to 5yr average multiple)

§  We don’t think demonstrating further upside is necessary but can imagine a much more optimistic scenario if BIG secures major brand name closeouts that drive comp acceleration because closeouts in non-food/consumables categories carry ~50% gross margins. For example, if BIG’s FY22 closeouts mix goes from 10% to 20%, with half of those sales being incremental and half replacing average-margin sales, it would generate ~$165M in incremental EBITDA.

Catalysts

-          Q2 guidance update (to come in early July as per BIG’s 6/16 press release)

-          Announcement of buyback

-          Appearance of traffic-driving closeouts in stores

-          The activist group continues to agitate for further changes and asserts that BIG has over $400M in additional unmonetized real estate assets: https://www.prnewswire.com/news-releases/investor-group-responds-to-saleleaseback-transaction-announced-by-big-lots-301037970.html. We do not underwrite or consider this in our work.

Risks

-          Operating performance below our expectations

o   BIG could certainly underperform even our Downside scenario, especially if stores need to be closed again. However, we believe BIG’s balance sheet and extremely low valuation provide insulation, especially relative to peers.

-          Strategic missteps

o   BIG trades where it does today in part due to strategic missteps. It is possible that management continues to make decisions which lead to share loss. We believe this risk is somewhat mitigated by the involvement of activist investors and recent additions to BIG’s board.

-          Value trap

o   BIG has been a “value” name since 2018 with relatively little to show for it. However, the company has firmly committed to returning cash to shareholders on multiple occasions. We expect that if we are right about its ongoing cash generation that its cashflow yield will not be ignored for much longer.

Closing thoughts

We acknowledge there are counterarguments to our thesis. The SLB has increased BIG’s operating leverage. BIG is experiencing COVID tailwinds in 1H FY21 which may be pulling forward sales from 2H. Discretionary consumer spending (esp. on furniture) may drop if the economy doesn’t recover and stimulus fades. BIG’s strategic moves over the past few years have not paid off and its performance lags peers.

All of these are valid points, but the stark realities of balance sheet math demonstrate that the market has failed to adequately price in the extent to which BIG has/will buy down its basis near term due to SLB and strong current trends. We speculate that this dynamic is driven by BIG’s optically strong rebound from the lows along with the massive recent factor outperformance of Growth and Momentum stocks (up 10-25% YTD) relative to Value (down ~27%). See below.

In order to see significant downside to this stock we think you either need a compelling reason to believe that post-COVID normalized EBITDA will collapse permanently or underwrite a multiple that solvent companies with substantial dividends simply do not trade for. On the other hand, significant base case upside requires no heroic assumptions, and any incremental benefit from closeouts pushes upside to the triple digits. All of that aside, we are living in an extraordinarily fluid environment, replete with wildly divergent retail/consumer scenarios, which most of us cannot handicap with confidence. For this reason, stocks which are poised to thrive in (or at least survive) most macro scenarios are trading at significant premiums to their historic valuations. BIG clearly falls in this category, but shares are currently trading at the bottom of the bargain bin.

Appendix

Price Comparison

Disclaimer: At the time of publication, the author of this article holds a long position in BIG LOTS INC. This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains if the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information, or as to the results to be obtained from its use.  All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

-          Q2 guidance update (to come in early July as per BIG’s 6/16 press release)

-          Announcement of buyback

-          Appearance of traffic-driving closeouts in stores

-          The activist group continues to agitate for further changes and asserts that BIG has over $400M in additional unmonetized real estate assets: https://www.prnewswire.com/news-releases/investor-group-responds-to-saleleaseback-transaction-announced-by-big-lots-301037970.html. We do not underwrite or consider this in our work.