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BIG AT A GLANCE

P/E ► 13.0 LOW EV/EBITDA ► 6.48 LOW ROA ► 11% HIGH ROE ► 20.4% AVG Debt to Equity ► 0.727 AVG Current Ratio ► 1.92 AVG Interest Coverage Ratio ► 72.8 AVG

 

 

 

 

 

 

Big Lots (NYSE:BIG) is a U.S. off-price retailer that sells everything from food and clothes to furniture and appliances. Specifically, it is a closeout retailer -- it purchases merchandise, at very low prices, directly from vendors that result from production overruns, packaging changes, discontinued products, liquidations, or returns -- and thus is able to offer products at much lower prices than traditional discount retailers like Dollar Tree Stores (DLTR). ^[1] The company is also able to acquire merchandise from brand name retailers and appeals not only to the lower-class but also price-conscious middle-class consumers. At the end of 2008, Big Lots operated 1,339 stores in 47 states across the United States and generated $4.6 billion in net sales^[2][3] -- its sales places it as a comparably-sized competitor against dollar-discount stores such as Family Dollar Stores (FDO) and Dollar Tree Stores (DLTR), which had net sales of $7.0 billion^[4] and $4.6 billion^[5] in 2008, but significantly behind low-end retailers such as Wal-Mart (WMT), which had net sales of $401 billion in FY2009.^[6]

Despite the fact that Big Lots targets price-conscious customers, it, as have most other retail and department stores, has suffered since the U.S. economy slipped into a recession at the end of 2007.^[7] As a result, in 2008, Big Lots' net revenue and net income fell 0.2% and 4.4% respectively as consumers cut down on consumer spending and increased company expenses.^[2] However, Big Lots' was shielded somewhat by its position has a niche market retailer for thrift-minded middle-class consumers who put emphasis on quality and value -- in 2008, the company's comparable store sales actually rose 0.5% and operating margins rose 0.4%.^[2] Additionally, in 2009 the company plans to operate a net increase of 5 stores, which is significant because since 2005 the company has had annual net decreases in the number of operational stores.^[8][9]

Company Overview

Business Model

Big Lots is a national retailer of closeout merchandise that results from production overruns, packaging changes, discontinuation of products, liquidations, and returns. The company's business model is organized into two distinct and important steps. The first step is to find and maintain a steady supply of closeout merchandise. Due to the nature of closeout merchandise, BIG has formed important arrangements with top vendors to ensure that its store are stocked with merchandise from all categories. In 2008, the largest vendor of closeout merchandise accounted for 3% of BIG's total purchases, and the top ten vendors accounted for 14% of total purchases.^[10] The second step is to price significantly below general and other discount retailers to appeal to value-minded consumers interested in purchasing brand-name merchandise at a large discount.

Business Segments

Big Lots sells closeout merchandise from different retail categories, including:^[11]

• Consumables (28.8% of net sales): food, health and beauty, plastics, paper, chemical, and pet products.
• Home (16.8% of net sales): domestics, stationery, and home decorative products.
• Furniture (14.8% of net sales): upholstery, mattresses, bedroom, dining room, and occasional furniture.
• Hardlines (13.5% of net sales): appliances, electronics, video games, tools, and home maintenance products.
• Seasonal (12.8% of net sales): lawn & garden, Christmas, summer, and other holiday products.
• Other (13.3% of net sales): toy, jewelry, infant accessories, and apparel products.

Consumables were the largest category in FY2008, consisting of 30% of net sales revenue, which is 1.2% higher than the 28.8% statistic from the previous year.^[11]

WIN Strategy

In August 2005, Big Lots introduced a new operating strategy called the What’s Important Now Strategy (“WIN Strategy"). The new strategy focused on improving three main elements: merchandising, real estate, and cost structure. In the merchandising strategy, the company planned to provide unmatched value, better quality, and to increase the recognized brand name merchandise as a percentage of the overall merchandise assortment. The company's real estate strategy to increase expansion hit a roadblock with the economic recession. However, in 2009, because of increased store productivity and the weak real estate market, the company plans to increase its store base for the first time since 2005. Lastly, the cost structure strategy was aimed to reduce expenses by reducing inventory and lowering distribution costs. As a result, operating profit has gone from 0.6% of net sales in 2005 to 5.5% in 2008.^[12]

Business Growth

FY 2008 (ended February 2, 2008)^[2]

• BIG's 2008 net income totaled $152 million, a 4.4% decrease from FY2007. Net margin during 2008 was 3.3% of net sales revenue.

• Total net revenue was $4.65 billion, a decrease of 0.2% from $4.66 billion in FY2007. The company attributes the decrease in revenue to the effect of the sluggish economy on customers as well as a decrease in the number of open stores. The decrease in net revenue was partially offset by the 0.5% in comparable store sales during the year.

• Comparable store sales increased 0.5% in FY2008 for stores that have been opened two years or more, and sales per retail square footage held steady at $160 in 2008, slightly higher than the $158 in 2007. The steady performance of per-store sales helped to offset the decrease in net sales.

• Selling & adminstrative expenses were up 30 bps to 32.8% of net sales from the 32.5% of net sales in FY2007 despite BIG's continued effort with the "WIN Strategy" to cut costs and improve profit margins. The increase in expenses was attributed to higher medical plan and share-based compensation expenses.

• At the end of 2008, BIG operated 1,339 stores, a net decrease of 14 stores when compared to 1,353 stores at the end of 2007.^[3]

Q2 2009 (ended August 1, 2009)^[13]

• Big Lots' net income increased 9.3% year-over-year, from $26.02 million in Q2 2008 to $28.44 million in Q2 2009 despite a decline in net sales due to recessionary pressures from the economic downturn. Part of the increase in net income was due to the decrease in SG&A expenses.

• Net sales was $1.09 billion in Q2 2009, down 1.6% from net sales of the prior-year quarter. The decrease in comparable store sales accounted for $25.8 million of the decrease in revenue. However, the company's strong wholesale operations and online sales increased net sales by $7.2 million.

• Comparable store sales decreased by 2.4% during Q2 2009, a slight improvement from Q2 2008 when comparable store sales decreased by 2.8%. In 2009, the decrease in same store sales decreased net sales by $25.8 million.

• Operating profit for Q2 2009 was $47.7 million, and operating margin was 4.4% of net sales. This is a 50 bps increase from Q2 2008, during which operating profit was $43.5 million, or 3.9% of net sales.

Trends and Forces

Economic Downturn and Weak Retail Generates Larger Supply of Closeout Merchandise

In December 2008 the National Bureau of Economic Research reported that the U.S. economy had been in a recession since December 2007.^[7] The recession was spurred by the 2008 Financial Crisis and has resulted in a significant decline in consumer spending, which has hurt the retail industry. In December 2008, total retail sales fell 2.7% in the U.S., marking the sixth consecutive month of negative sales.^[14] The retail industry's struggles have continued well into 2009 as the industry reported a 4.9% decrease sales decline in June.^[15]

As the recession continues from 2008 to 2009 and as many retail stores continue to struggle getting merchandise off store shelves, many retail stores are left with excess inventory. Additionally, bankrupt retailers, like Circuit City Stores (CCTYQ), Linens n' Things, and KB Toys, that are entering the liquidation phase are looking to get rid of merchandise by all means necessary. Both of these occurrences are highly advantageous for Big Lots, which relies on finding sources of closeout merchandise from brand-name retailers to maintain its store inventory of discounted goods. Furthermore, as general retailers and bankrupt companies are eager to clear out excess merchandise, Big Lots may be able to purchase closeout merchandise at lower prices, reducing cost and increasing profit margins. ^[16]

Consumers Look to Discount Retailers during Economic Downturns

Big Lots targets not only lower-class consumers but also the price-conscious middle-class segment of the retail market because it sells brand-name items, at heavily discounted prices, which preferred by middle-class consumers. The business model especially appeals to more middle-class consumers during tough economic times as consumers become more thrifty during but still want to maintain the quality of merchandise they purchase. In general, most discount retailers, have either done well or not been hurt too much during the economic struggle.^[17][18] In 2008, Big Lots' comparable store sales increased by 0.5% showing that the company is seeing increased traffic. However, despite its appeal as a discounted retailer of brand name products, Big Lots has not been able to completely offset the negative pressures of the recession -- in 2008, the company also had a 0.2% decrease in net sales and a 4.4% decrease in net income.^[2]

Merchandise Supply Affected by Exchange Rates

In 2008, Big Lots purchased 27% of its merchandise directly from foreign vendors (a 2% increase from 2007) with 21% from Chinese vendors alone.^[19] A substantial portion of the merchandise Big Lots purchases domestically are also originally supplied by overseas vendors. As the value of the dollar fluctuates against foreign currencies, especially the Chinese yuan, Big Lots risks decreases in its profit margins, since the cost of acquiring merchandise from overseas vendors will increase if the dollar weakens relative to foreign currencies.^[20]

Dependence on Business in Four States

Big Lots stores are concentrated heavily in California, Texas, Florida, and Ohio, with 37% of the company's stores (494 stores) located in these states. In 2008, sales from stores in the four states accounted for 38% of the company's total revenue.^[3] The local economies of these states plays an important factor in the sales and risk of the company in two ways. The first is that if retail companies in these states build up inventory or become liquidated, Big Lots will have the power to substantially increase its merchandise and product diversity and attract more customers to its stores. The second is that if the local economies of these states are hit too hard by the recession, it causes consumers to cut back on discretionary spending and avoid Big Lots' stores despite the low prices.

Competition

Big Lots vs. Dollar Stores

Big Lots is a discount retailer that competes with other stores that have similar business models. Thus, Big Lots faces direct competition from dollar-store chains, such as Family Dollar Stores (FDO) and Dollar Tree Stores, that sell many products are very low prices.

Description of dollar store companies:

• Family Dollar Stores (FDO): operates 6,598 stores in 44 states. Most of the merchandise the company sells ranges from less than a dollar to around $10 in price, with the majority under $1 per unit.^[21]

• Dollar Tree Stores (DLTR): operates 3,591 stores in 48 states. The company is the largest retailer offering a fixed price of $1 on all merchandise in its stores.^[22]

Big Lots vs. Big-Box Sellers

As a discount retailer, Big Lots also faces significant competition from big-box sellers, such as Wal-Mart Stores (WMT) and Target (TGT), whose enormous scale allows each to extract value in their inventory purchases and pass these savings on to consumers. With an average square footage per store of 29,800 sq. ft., Big Lots stores are smaller than Wal-Mart's or Target's, but larger than comparable dollar discount retailers. In some sense, it is more nimble and less concentrated than big-box competitors, but does not necessarily enjoy the same economies of scale (though, as a large closeout discount retailer, it has some).

Description of big-box sellers:

• Wal-Mart (WMT): is the world's third largest company^[23] with 7,873 stores worldwide. Because of its mammoth size and buying power, Wal-Mart can buy its products at rock-bottom prices, exchanging high purchase volumes for low cost while passing the savings onto its customers.^[24]

• Target (TGT): operates 1,682 stores in 48 states. Target offers a range of general merchandise in a similar store format to Wal-Mart but targets a higher income demographic than that of Big Lots and Wal-Mart.^[25]

Footnotes

1. ↑ BIG 2008 10-K, pg. 1
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7} BIG 2008 10-K, pg. 16
3. ↑ ^{3.0 3.1 3.2} BIG 2008 10-K, pg. 2
4. ↑ ^{4.0 4.1} FDO 2008 10-K, pg. 30
5. ↑ ^{5.0 5.1} DLTR 2008 10-K, pg. 18
6. ↑ ^{6.0 6.1} WMT 2009 10-K, Exhibit 13, pg. 1
7. ↑ ^{7.0 7.1} Wall Street Journal "Recession Turns Malls Into Ghost Towns" 22 May 2009
8. ↑ BIG 2008 10-K, pg. 20
9. ↑ Reuters "Big Lots Expands Despite Economic Downturn" 4 May 2009
10. ↑ BIG 2008 10-K, pg. 3
11. ↑ ^{11.0 11.1} BIG 2008 10-K, pg. 22
12. ↑ BIG 2008 10-K, pg. 19
13. ↑ ^{13.0 13.1} BIG Q2 2009 Report, pg. 2
14. ↑ New York Times "Weak Economy and Retail Sales Hurt Shares" 14 Jan 2009
15. ↑ New York Times "June Is Another Weak Month for U.S. Retail Sales" 9 July 2009
16. ↑ Reuters "U.S. retail cuts helped some inventory companies" 25 Jan 2009
17. ↑ Seeking Alpha "Discount Retailers Thriving in Recession" 7 Jan 2009
18. ↑ CNN Money "Cheap is the new black for retail" 28 Nov 2008
19. ↑ BIG 2008 10-K, pg. 7
20. ↑ New York Times "The Almighty Renminbi?" 13 May 2009
21. ↑ FDO 2008 10-K, pg. 13
22. ↑ DLTR 2008 10-K, pg. 13
23. ↑ CNN Money "Fortune Global 500"
24. ↑ WMT 2009 10-K, Exhibit 13, pg. 46-47
25. ↑ TGT 2008 10-K, pg. 7
26. ↑ TGT 2008 10-K, pg 26