Dividend growth investing is a popular and largely successful approach to generating wealth over long periods of time. We will be spotlighting numerous dividend up-and-comers to identify the best "dividend growth stocks of tomorrow." Today we look at a retail company in the midst of a transformation in Big Lots, Inc. (NYSE:BIG). Struggling since the recession, Big Lots is rebranding itself and investing in store remodels and e-commerce to revive growth. While the company still has a lot to prove at the operational level, investors can find potential opportunity in a solid balance sheet, high yielding dividend, and cheap stock valuation that provides a margin of safety.
Big Lots, Inc. is a non-traditional retailer that operates in the United States. The company provides both traditionally sourced, and "close-out" merchandise to discount focused consumers. The company offers various types of products for sale including furniture, home goods, toys, electronics, grocery, textiles, and seasonal items. The company operates approximately 1,401 stores in 47 US states.
In a cut-throat industry ripe with competition, Big Lots has managed to survive. With that said, growth has been somewhat lacking over the years. Revenue has grown at a CAGR of just 1.38% over the past decade, while EPS has grown at a CAGR of 4.99%.
We can see from the historical comparable sales growth of Big Lots, that the business never regained its level of performance from prior to the recession a decade ago. After averaging mid-single digit sales growth in the early 2000s, sales growth has slumped to the low-single digits over much of the past decade.
Before we analyze the company's journey moving forward, we will dive into how efficiently Big Lots has operated as a business. To do this, we will look at a handful of key operating metrics.
We review operating margins to make sure the company is consistently profitable. We also want to invest in companies with strong cash flow streams, so we look at the conversion rate of revenue to free cash flow. Lastly, we want to see that management is effectively deploying the company's financial resources, so we review the cash rate of return on invested capital (CROCI). We will do all of these using three benchmarks:
We see from the charts above that Big Lots has come under some substantial operational pressure over time. All three metrics have steadily contracted. The company has come under pressure from emerging competition online such as Amazon (AMZN), as well as suffered cost pressures related to the ongoing trade dispute with China. The margin pressure has put a bit of strain on FCF generation (as well as increased CAPEX on a new distribution center and store remodels which we will discuss later). The retail sector is extremely competitive, and it becomes apparent from the data that Big Lots has had a tough time separating itself from the field.
With operational metrics declining, investors may be curious how this has impacted the balance sheet. The balance sheet is a crucial element of any potential investment. An otherwise solid company can be a poor investment if that business is over-leveraged. Too much debt can restrict cash flow, and expose investors to risk should the company face an unexpected downturn in its business.
We see a mixed bag here. On one hand, the balance sheet is quite solid. The company carries $53.7 million in cash against $467.8 million in total debt (a ratio of 8.8 to 1). Furthermore, the company's leverage ratio of 1.0X EBITDA is very solid - well below our cautionary benchmark of 2.5X. Despite the strong current standing, the balance sheet is trending in the wrong direction. Leverage has crept higher as the business has struggled. It's fortunate that the balance sheet was strong enough to absorb this under-performance, but it's not a good long-term story.
Big Lots is new to the dividend growth scene, having raised its dividend each of the past five years after establishing it in 2014. Investors looking to generate income will be happy to find that the current annual dividend of $1.20 per share yields a whopping 5.35% on the current share price. This easily surpasses what 10 year US treasuries are currently offering at 1.84%.
Despite a high yield, the dividend has also been aggressively raised. Over the past three years, the payout has grown at a CAGR of 16.4%. The company is currently due to raise its payout, so investors will want to watch out for that. Despite a poor cash payout ratio, the company has recently jacked up CAPEX to remodel stores and build a distribution center - which skews that metric (seen in the below chart). The balance sheet is easily capable of helping fund the payout that amounts to a more friendly 40% payout on an earnings basis. We suspect that the dividend has been raised a bit too rapidly in the face of increased capital investments. We expect dividend growth to drastically slow down from here. Because of the strong balance sheet, we conclude that the dividend payout is safe at this time. As CAPEX slows down, the dividend will be more visibly supported.
Big Lots has also made efforts over the years to reduce its share count to benefit investors. Buybacks have ranged in intensity, and have trended lower due to increased CAPEX in recent years. Still, the float has been cut in half over the past decade.
Now that we have identified what has been a prolonged downtrend in operational performance, we can look at what the company is doing to turn things around, and what risk factors exist to damage these efforts.
Big Lots has really re-thought their brand in recent years. The company began remaking its brand image in 2014. Despite CEO David Campisi retiring in 2018, the efforts to rebrand Big Lots still continue to this day. Stores are being remodeled to showcase an inviting atmosphere that emphasizes core product categories such as furniture.
source: Columbus Business First
Current CEO Bruce Thorn has continued this push, and the results have been encouraging. The company has seen a high single-digit to low-double digit sales increase at remodeled stores in major markets.
Big Lots is also looking for traction as it joins the e-commerce battlefield. The company launched its online store in 2016, and just this summer began rolling out a buy online - pickup in store program. The store remodels and increased supply chain spending to support its online business will prolong its uptick in capital spending, but the company is investing to drive top line growth and the balance sheet is stable enough to support these efforts. It is certainly too early to determine the company's level of success. Thus, execution risk remains present.
We also remain somewhat cautious about the exposure that Big Lots has to US consumer spending. The company has shifted its exposure in part towards larger ticket items such as furniture and away from smaller, more defensive categories such as grocery and clothing. This could negatively impact the business should a recessionary environment form where consumers are cutting back on such purchases.
The 2019 year has been a tough one for investors. The stock has ranged between $19-$45 per share, and currently trades near the bottom of that range.
Based on analyst estimates for the 2020 fiscal year, Big Lots is expected to earn approximately $3.79 per share. The current share price puts the stock at an earnings multiple of just 5.94X. This is about 54% off of its 10 year median P/E ratio of 12.99X.
With such a large discrepancy on an earnings basis, we will look at the stock's price to book value to gain additional insight. At just 1.36X, the ratio is at decade lows - even lower than what it was coming out of the recession.
It's clear that the market is very pessimistic about Big Lots at the present time. However, there are some positives to be had. The company's new California distribution center will become operational in spring of 2020, which will reduce some of the company's CAPEX levels. Management is also committed to a growth strategy that is at least showing promise as remodeled stores see a boost, and the company's e-commerce business begins to look for traction. There are certainly risks that the company falls short on execution, but the stock is so beaten down that investors are looking at a nice margin of safety at current levels.
Big Lots certainly isn't a best of breed among its retail peer group. However, Big Lots is also offering investors a high yielding dividend that is covered by a solid balance sheet. The company is not sitting on its hands - and pursuing growth with an agenda that will require some time to pass judgement on. In the meantime, investors can enjoy a very discounted stock that will pay you for your patience. We aren't bullish on Big Lots as a "buy it and forget it" investment, but rather a potential rebound opportunity. The depressed stock price leaves more upside than downside in our conclusion.
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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.