The focus of this blog is (obviously) microcap and deep value stocks. However, just because I focus on microcap stocks doesn’t mean I turn a complete blind eye to large cap companies (my position in Dreamworks (DWA) is actually one of my largest). After all, Buffett focused on microcaps during his partnership days, but probably his biggest winner was American Express in the mid 60s after the salad oil scandal.
So with that in mind, I thought I’d take a look into Big Lots (BIG) The thought process behind my interest was pretty simple: a quick glance at their yahoo finance page showed 20%+ ROE with little leverage and a P/E <10x.
Digging a little deeper revealed a pretty strong management team as well. Current management has dramatically improved the business since taking over in 2005, and they’ve shown a talent for capital allocation. When new store openings didn’t make sense due to high real estate prices in the 05-08 time frame, management focused on buying back shares. When real estate prices softened, they increased their store count while continuing to buyback shares at a strong pace.
Finally, I’ve been impressed w/ the size of their share buybacks: management spent $250m on share repurchases in the first half of 2012, more than 10% of the company’s market cap!!! That’s really, really impressive.
So those are the positives. And the valuation looks really tempting too- I’ve got their EV / EBITDA at 5x, which is not only cheaper than Walmart, Target, Family Dollar, and Dollar General (WMT and TGT in the 8x range, Family Dollar and Dollar General 9-10x), it’s even cheaper than Supervalu (5.5x and whispers that bankruptcy is on the table).
But I’ve got one big concern here: Big Lots is a closeout retailer. What this means is they take inventory that manufacturers / vendors no longer want (whether it’s because they’re overstocked, changing packinging, liquidating, etc.), buy it en bulk for a discount, and then sell it in their stores.
Traditionally, the business had a pretty nice moat. When a company decides to liquidate a line or change it’s packaging, they want to get rid of that inventory quickly. Big Lots is one of the few retailers with the scale to take large amounts of inventory of their hands quickly, which means they’re the retailer vendors turn to. The other big advantage that Big Lots has (aside from scale) is that they already had the relationships with vendors so that vendors would consider calling them when they had to unload inventory. It’s tough for a start up to replicate that relationship.
But my big worry here is that moat is disappearing. The world of retailing is changing with online sales, and it seems like online retailing is perfectly situated getting rid of excess inventory / overruns. Big Lots gross margins are 40%… if I’m a manufacturer, why let Big Lots take up that much margin when I could run a bulk sale through a blast email, or a clearance section online, or even a groupon or something?
My other concern is the possibility for margin erosion. Take a glance at their operating margins for the past ten years: fiscal 2010-2012 stand out as anamolies at 6.6-7.2%. Befor that, it looks like the business was operating pretty consistently at 3-4% operating margins. If you revert that to EBITDA, you’ll find EBITDA margins in the 4-5% range. Apply those margins to today’s sales, and suddenly Big Lots would look fairly valued compared to Walmart and Target.
Overall, I think Big Lots looks cheap. I’d probably rather own it than the broad index over the next five years. But I don’t think there’s a huge margin of safety at today’s prices. If either 1) online retailing steals sales or 2) margins continue to contract, Big Lots looks at best fairly valued and at worst significantly overvalued at today’s prices.
Still, an interesting one to keep an eye on.
Disclosure: Long DWA
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