Is Big Lots A Big 'Buy' Ahead Of Earnings?

Summary

• Big Lots continues to trade at a multiple significantly below the market (8.56X P/E).
• The company reported a surprise Net Loss in Q3, due to increased SG&A expenses.
• The company is currently in the middle of $250M to create the "Store of the Future."

Today, I wanted to perform a dividend stock analysis on a company headquartered in my home state. The Buckeye State, aka, Ohio. In our journey to find undervalued dividend growth stocks, today's analysis will focus on a company that provides their customers with frequent discounts on everyday home goods, furniture, food. Their tagline says it all: Serve Big. Save Lots. They aren't a discount store, and they aren't a big-box retailer. They are Big Lots, Inc. (NYSE:BIG). After their recent quarter, the price fell dramatically. But, are they considered an undervalued dividend growth stock? Well, let's roll up our sleeves and find out!

The "Store of the Future"

Big Lots operates in nearly all 50 states (47) and has over 1,400 stores. Interestingly, in an era where some retailers are shrinking their footprint, Big Lots is doing the opposite. In fact, the company recently announced the opening of 17 new stores on the same day in the fourth quarter! But this store opening was not an isolated incident. Rather, it is part of a larger store expansion and remodeling plan. Performing more research, I stumbled across this great article published in 2017 discussing the expansion plan. Big Lots is labeling this growth and remodeling as the "Store of the Future." Big Lots estimates this strategy will cost over $250M (M = million) during the period.

What is the company spending this capital on? Implementing the company's new strategy and store format. As a part of the "Store of the Future" concept, the strategy will focus on placing certain goods, such as furniture, seasonal items, and soft home, at the front of the store to capture customers attention. On top of it, the chain is commuting to improving the in-store shopping experience.

My instant reaction to reading the new store format and design is that the company is looking to capitalize on some of the store formatting and offerings that have made stores under the TJX Companies (TJX) brand so successful. My wife and I walked into a newer TJMaxx yesterday in fact and were greeted with a massive furniture and home section. However, Big Lots will continue to differentiate itself from TJX by offering discounts on everyday items like groceries and other household supplies. In the past, Lanny (the other Diplomat) and I have walked through plenty of Big Lots and noticed the great deals offered on furniture. It is exciting to see them rearrange and adjust the stores' layout to further highlight the great discounts they are offering. You bet that I'll be checking out my local Big Lots to see this strategy first hand this week.

Balance Sheet and Income Statement Analysis

When I think of a massive store expansion, my mind instantly asks "How is this being funded?" Before running our infamous stock screener, I wanted to take a few moments to perform an analysis of the company's balance sheet and income statement based on the results of the company's last earnings release/10-Q. First, I'll start with the balance sheet.

Balance Sheet

In this section, I'll review the company's debt levels and current ratio. First, let's start with the debt. At the company's last quarter end (11/2/18), the company's long-term debt was $488m, an increase of $116.1m compared to the previous year's balance of $371.9m. Well, I think I've answered the question about how Big Lots financed the expansion and remodeling.

In December, S&P downgraded their debt rating from BBB to BBB- based on a negative outlook. Big Lots' debt is still considered investment grade. However, the explanation provided by S&P for the downgrade wasn't exactly "rosy" either. S&P cited that the company will be under pressure in the short-term future due to the poor performance of the food and consumables sector, which historically was a primary driver of traffic to the store. The article cited that the segment has "posting negative comparable store sales over the past two years, pressuring EBITDA margins." S&P also cited pressure from box stores/dollar stores on the company's performance, along with the uncertainty surrounding the execution of the company's new strategy. The decrease in consumer staples was eye-opening to read, given the fact that I mentioned this was a differentiator for Big Lots earlier when compared to TJX.

With growing debt, I also like to take a look at the company's current ratio to determine if the company can cover their short-term liabilities with their short-term assets (short-term is considered 12 months or less). A ratio over 1X indicates that the short-term liabilities are covered and something we like to see in a growing debt environment. The company's current assets and current liabilities at 11/2/18 were $1,277.2M and $745.6M, respectively. This is a ratio of 1.71X. Great to see.

Income Statement

With the balance sheet reviewed, we will focus our attention on the income statement for a quick review. We will review the company's performance in their last earnings release, same store growth, and provide an update on management's guidance. There is a lot to unpack, so I'll keep it brief!

Right away, the company's last earnings release contained two words that caused my ears to perk. "Net Loss." Hence, why the company's stock price sharply fell after the results were released. The company reported ($6.5M) in net income, or ($.16)/share. Looking at the company's income statement, the primary driver of the net loss was a $28.5M increase in SG&A expenses. Other drivers included increased depreciation expense ($1.1 YOY increase) and interest expense ($1.2M YOY increase) as a result of the increased debt levels.

There were some positives cited in the earnings release, including a 3.4% increase in same store sales and the fact the company has returned $139M to shareholders via share buybacks. Further, the company provided an update on their earnings guidance. The company is expecting diluted EPS of $3.55-3.75/share, which is a decrease compared to $4.45/share in 2017.

Overall, while comparable store sales are increasing, costs are increasing at a larger pace. Further, interest expense will continue to increase as management increases their debt load. Remember, these results were as of 11/2/18. This does not include the holiday sale season or the full impact of tariffs or the sharp rise in interest rates that occurred in December. So, the Q4 results that should be published in February shall be very interesting, and hopefully, they can reverse some of the trends that presented themselves in the third quarter.

Dividend Diplomats Stock Screener

Now, it is time to run Big Lots through the Dividend Diplomats' Stock Screener to see if the company currently passes our investment filters used to identify undervalued dividend growth stocks. If a company passes our screener and a few other metrics, we will consider purchasing. Our stock screener uses three simple screens to identify the stocks: P/E ratio (valuation), dividend payout ratio (ability to continue growing their dividend), and their dividend growth rate/history of increasing their dividend (as we focus on companies that have demonstrated their ability to increase their dividend over a long period of time). Let's see the results!

Ticker	Price - 2/1/19	Forward EPS	Annual Dividend	Yield	Payout Ratio	P/E Ratio
BIG	$31.32	$3.66	$1.20	3.83%	32.79%	8.56

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**Sources: Pricing information, forward EPS, and annual dividend were obtained from Yahoo Finance. The remaining figures in the table above were calculated by the author.

1) Dividend Yield: Typically, I look to invest in companies with dividend yields exceeding the S&P 500 yield of just under 2%. Otherwise, I would consider investing in a nice, diversified S&P 500 mutual fund, or ETF. BIG's 3.83% dividend yield is definitely higher than the market and is pretty solid.

2) Payout Ratio: We typically use a 60% threshold when reviewing a company's payout ratio, as we believe this percentage point allows a company to continue to grow their dividend going forward without sacrificing the safety of their dividend. BIG performs very well in this metric and their low payout ratio of 32.79% provides management plenty of room to grow their dividend going forward.

3) Dividend History and Dividend Growth Rate: BIG is relatively new to the dividend growth investing game. The company started paying a dividend and increasing their dividend annually since 2014. The company's 3-year dividend growth rate is 16.52% (per dividendinvestor.com). The company is also expected to announce a dividend increase in March. This should be a very interesting dividend increase, given the company's recent performance. If the Q4 results that are announced aren't great, I could see a much lower percent dividend increase than the past. I could also see the company lowering their dividend growth rate this year due to the capital required to execute their "Store of the Future" plan. Due to the short dividend paying history, I cannot say that the company has demonstrated a long-term commitment to increasing their dividend. They have demonstrated their desire to increase their dividend in the first four years of dividend payments. But let's see if they do it in the face of some adversity.

4) P/E Ratio: The final metric of our stock screener focuses on the current valuation of the company. I'm always looking for companies that are trading at a multiple below the broader market. Currently, the broader market has a historical P/E ratio in the mid-20x and a forward P/E ratio between 17x and 18x (per The Wall Street Journal). BIG's P/E Ratio is WELL below our threshold, and the company appears to be trading at a significant discount to the market.

Summary

Despite the fact that BIG passed a few of the metrics of our stock screener (P/E, Payout Ratio), I am going to pass on investing in the company at this time. The key to this decision was the company's operating results, and some of the balance sheet trends noted. The company is in the midst of a massive remodeling that will be capital intensive. The store updates and new stores should increase sales, drive increase traffic, and increase earnings. Potentially. However, the company also has demonstrated shrinking margins, increased costs, and reported a net loss last quarter. Further, Big Lots is already increasing their debt load, and their credit rating has been downgraded subsequently (as discussed earlier).

The Q4 results will tell a lot about the company, considering it will include the results from the holiday season. Historically, this has been the company's highest earning quarter. How will this remodeling pay off during the season? Will the company continue same store growth? Or will margins continue to shrink, along with the company's earnings? Right now, there are a lot of unknowns. And because of the unknowns, despite the metrics, I cannot invest in the company prior to their next earnings release. There are plenty of other undervalued dividend growth stocks for me to invest in, so I will focus my attention elsewhere for the time being and revisit Big Lots after their next earnings release.

What are your thoughts about Big Lots? Am I being too pessimistic based on their last quarter's results? Or are you a believer in their new strategy? Have you shopped at the "Store of the Future" and had a pleasant experience? I can't wait to read your responses!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.