Big Lots Hits Pause

Summary

• Big Lots reported fiscal 2019 fourth-quarter and full-year results on February 27th. Sales improved slightly. But the bottom line on an adjusted basis declined.
• Guidance for fiscal 2020 was equally disappointing. But the big news was the retailer's decision to slow the pace of store remodels.
• Now, activists have established a position.

My investment thesis on Big Lots (NYSE:BIG) was based on the retailer's transformation from overstock and close-out discount retailer to a non-traditional discount retailer with a strong focus on furniture and home. Certainly, there have been pressures and challenges in that industry. Under a new CEO and attempting to infiltrate a more upscale consumer base, Kirkland (KIRK) has been weighed down by fewer sales on lower traffic and now trades in the $1 range. Pier 1 Imports (PIR) filed for bankruptcy in February. But Big Lots was looking to materialize on the market disruptions and capture share. And the plan seemed to be working...until December 15th. Potential investors must now consider whether the presence of activists will prove positive.

This transformation trail traces back to 2016. In September 2017, after 18 months of discovery, Big Lots introduced a three-year mission. The mission would require one of the largest investments since the company's inception - remodeling locations based on a "Store of the Future" format.

"The layout of the store is dramatically different from the traditional Big Lots by featuring Furniture front and center in the store with Seasonal and Home also at the front on either side. Pantry - which includes Food and Consumables - is located in the back of the store, but is clearly visible from the front of the store given the low-profile of our Furniture assortment."

But the timeline was delayed when the new mission's champion, CEO David Campisi, had to take a medical leave of absence in December 2017. In April, 2018, he retired to focus on his health.

The company announced Bruce Thorn would be its new CEO in late September 2018. Not all of his initial decisions resonated with me. But he did light a fire under the retailer's plans for its Store of the Future remodels. The stores were seeing increased sales at a high-single-digit percentage.

We intend to move swiftly here accelerating the number of remodels in 2019, and challenging ourselves to get through the majority of the fleet in the next three years, quicker than originally planned.

By the end of the 2019 third quarter, 32% of stores, 452, had either been opened or remodeled with the format. The retailer projected half would be completed by the end of 2020. And, by the end of 2021, it expected to have completed the majority, approximately 90%, of locations.

He also engaged third-party consulting services to validate and/or expand the company's stated mission.

We've engaged a team of experts to help us enhance and accelerate our growth strategy and also help us expand margins and improve our bottom line longer term. Our leadership team will be working in tandem with this outsourced team to identify ways that we can strengthen and grow our "ownable" and "winnable" categories, while identifying new opportunities to drive productivity and improve customer traffic trends. Simultaneously, we will be searching for opportunities to enhance profitability and future growth efforts.

And there were positive results. By March 2019, the third-party consultants had validated three categories, Furniture, Seasonal and Soft Home, as well as the Consumables category as "winnable" and "ownable" for Big Lots.

We learned consumers have a strong association with us emotionally and functionally for price, value and treasure hunt. There are three critical elements to the customer value proposition that have emerged as the anchor for our growth strategy. First, be the authority on price and value. Second, increase accessibility of surprise and delight. And, finally, grow home and life's occasions.

One of the initiatives to grow out of the second and third elements has been dubbed the Lot. The Lot is approximately 500 square feet carved out near the front right corner of a store. The area features fresh products focused on events and holidays and changed every six weeks or so. Stores featuring the Lot have experienced a 1% to 2% lift in comparable sales.

Another initiative relative to the second element involves resizing and reequipping the retailer's food and consumables area, Pantry Optimization.

This initiative reconfigures our food and consumable assortments to strike the right balance between surprise and delight values from close-outs and consistent brand-name never-outs.

The retailer also tested Qlines, an impulse item availability concept near its checkout area to drive the build of a consumer's basket.

And, yet, the early successes from these initiatives have Big Lots putting the brakes on.

Fourth-Quarter & Full-Year Results

Big Lots reported fiscal 2019 fourth-quarter and full-year results ending February 1, 2020, on February 27th. For the quarter, sales increased 0.5% from $1.599 billion in 2018 to $1.607 billion in 2019. The bump was attributed primarily to a slightly higher store count. Comparable store sales actually declined 0.9% for the quarter.

Overall, the top line did not meet the retailer's expectations. In the third quarter earnings call, Mr. Thorn had hinted the fourth quarter was off to a solid start.

Sales in the month of November, which included Thanksgiving and Black Friday were ahead of plan and we are excited by the response from customers to our holiday assortments.

Historically, Big Lots has found sales rally in the 10 days before Christmas Day. In 2019, this did not materialize - "even with strong price cuts and promotional support".

The bottom line bore the brunt of the reaction. Net income dropped over 13% from $108 million in 2018 to $93.8 million in 2019. But, as a result of the company's active buyback program resulting in a 3% decline in the outstanding share count, diluted earnings dropped only 11% from $2.68 per share in 2018 to $2.39 per share in 2019.

For the year, sales improved 1.6% from $5.24 billion in fiscal 2018 to $5.32 billion in fiscal 2019. Including the $178.5 million gain on the sale of the company's California distribution center, net income increased 54.5% from $157 million in 2018 to $242.5 million in 2019. Yet, on an adjusted non-GAAP basis, earnings in 2019 at $3.67 per share declined 9% compared to earnings in 2018 at 4.04 per share.

It was disconcerting to see fiscal 2020 guidance for non-GAAP earnings in a range of $3.20 to $3.40 per diluted share.

The Big News

Alongside the unsettling fourth-quarter results, Big Lots shared the big news it was hitting the brakes on its Store of the Future implementation. Shares dropped over 30% initially. They continue to trade in the $16 to $18 range, more than 50% off the retailer's 52-week high of $39.53.

To be clear, Big Lots is not halting this initiative. Rather, it is dramatically slowing the pace. In 2020, the company plans to remodel just 80 stores. This appears quite sluggish when compared to the 205 it accomplished in 2019.

One contributor to the decision is the company's need to backtrack on prior remodels and incorporate the additional initiatives - Qline, the Lot and Pantry Optimization. Another contributor has to do with the expenses necessary to accomplish the feat. The company has adamantly insisted it will not expend capital if the return is not positive.

We'll be loading up in … good value engineering to bring the cost of the Store the Future down so that, as we roll it out going forward, it's much more productive.

Ultimately, the mission has not changed.

The growth lifts in the first year continue to be strong. Our customers do enjoy. Traffic still remains up versus balance of chain. Basket is still strong in terms of the growth.

But the method of change has changed.

The thing is, as we look at it, we know it can do better by having more disruption.

Enter Activists

Not everyone is convinced of the sapience of the slowdown decision. On March 5th, the Wall Street Journal reported Macellum Advisors and Ancora Advisors, activist investors, have established a 10% stake in the retailer. The two funds are reportedly nominating a new slate of nine directors to replace the existing Board.

It could be debated Big Lots' current board is a tad heavy on food industry experience - Jeffrey Berger, a former EVP at H.J. Heinz (now KHC), James Chambers, former CEO of Weight Watchers, Marla Gottschalk, former CEO of Pampered Chef, and Nancy Reardon, former SVP of Campbell Soup. Considering its current emphasis on furniture, it may be concerning only one board member, Wendy Schoppert, former EVP of Sleep Number (SNBR), hails from that industry. Only Marla Gottschalk has made an insider purchase in recent months when she acquired 1,850 shares for an average of $27.06 per share in December 2019.

It's also reported the two contend the retailer is doing too little too late.

Big Lots has missed out on the rising consumer demand for discount products.

Macellum and Ancora took an activist position in Bed, Bath & Beyond (BBBY) in 2019. Shares are down over 40% since.

Prior to Macellum's position in BBBY, its activist positions were taken in clothing retailers such as Perry Ellis (PERY), The Children's Place (PLCE) and Christopher & Banks (CBKC).

Ancora's activity in 2019 included an activist position in the restaurant chain, J. Alexander's Holdings (JAX), which it attempted but failed to take private for $11.75 per share. It now trades in the $7 to $8 range. The money manager includes previous successes with Shutterfly (SFLY) and Element Fleet Management (OTCPK:ELEEF) on its resume.

Ancora claims to prefer a "constructivist" approach initially and switches to "activist" only after resistance.

We almost always start out constructive, and it's only when things break down we end up in filings. We're not looking to be combative. We're really not.

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.

Comments

[Expanding Universe]

@Jenks Jumps and @discountshopper, one of my preferred areas of investment in a market for all seasons, the sort that is resilient during times of financial distress, have always been the discounters. I had a position for sometime when Big dropped to the high teens last year, stayed through their second to last earnings call and took profits when they started to rise through the new year. Frankly, I quite enjoyed their earnings calls. The team appears to have a terrific handle on dealing with the analyst community and just a few short months ago really did seem on the right track. I, too, was skeptical of the pivot to more furniture. These are difficult for any discounter to get right particularly in an era when generational and demographic consumer interests are changing. Frankly, I think a look at both the hip new dollar stores (Five) to the dominant players in that realm (DG and DLTR) provides some pretty powerful insights into how crucial high volume small footprint goods are to the success of these companies. As for Big, I do wish them great success. I admire the attempt to shift gears and do hope they are able to succeed with enough of their own know how and vision intact. At heart, I want the underdogs to succeed by default. It isn't always great to hear a company realize a flawed vision and redirect their approach but, once again, I hope it works. As for the activists, I have mixed feelings. Too often, activist investors insert themselves into the change narrative for a quick buck or just for the pr without being familiar with the sort of deep on the ground character of a company, the sort that can only come from real familiarity or patronage. I will concede there are a few agents of change out there who I seem to always find myself aligned with but in this case I really cannot say.

[Jenks Jumps]

Expanding Universe,

Thanks for adding these great talking points.

I have to admit Five Below stores are just opening in my area. I visited at most twice during the holiday shopping season to see if they carried specific items - they didn't. I can't see myself making this a routine place to visit. I'd rather go to Dollar Tree or Walmart and would rather shop T.J. Maxx, Home Goods, Marshalls, Ross or Big Lots.

Your points on the activists is spot on for me. I couldn't see enough of a track record to give me a ton of confidence.

Good luck in this trying environment!

[discountshopper]

What's up with these high level executives? They make things complicated when it is really very simple. They think that by overhauling things - according to their likes or values - that the business will take off just like that! What a bunch of high-fallutin words to describe management attempt to improve sales! A team to advice what to do to improve sales?
Just ask me... I'll give you my opinion and advice, free!
My advice:
It is really very simple. Find out what the people who shop frequently at your store buy AND why they go buy it at your store! If you asked me, I'll say "Good prices (meaning lower than anywhere else nearby) AND good selection of available items that I use almost on a daily basis, AND good location. Period!
Did I want to buy furniture? NO! So what makes you think that if you put a furniture store or home products in front that I will buy your furniture? My god! What a stupid idea. Why? because I already have enough furniture, and I can go to real furniture stores if I wanted furniture. And you'll just make me walk farther to the back of the store where I really want to do my shopping!
This IS the reason why the new numbers do NOT reflect the results expected from all the renovations. Soooo unnecessary, and sooo out of touch. Don't need a bunch of consultants nor master's degrees to figure this out. You people cannot see the forest for the trees! Sheesh!
Sorry, I have to be blunt.... but it is honest opinion. I like BIG LOTS!

[Jenks Jumps]

discountshopper,

Never be sorry for leaving your personal opinion on one of my articles! I very much appreciate hearing the perspectives of Big Lots' shoppers! I honestly believe this type of sharing helps us all be better investors.
I will admit, though, years ago, I was the type of Big Lots' shopper who only went in the store to see what type of furniture close-outs it may have. It is still not a go-to destination for me for anything. I only visit out of curiosity or if something in an ad or email catches my eye.
On a related subject, this type of action in the market may introduce Big Lots to new consumers if more become cautious about their personal spending.

[discountshopper]

Thank you Jenks for your nice reply.
For a while shortly after I posted my criticism, I felt a pang of remorse because I thought I may have been a bit harsh with my criticism (and wondered if I should ask SA mgmt to delete it) but your reply made me feel better.

Now, here's the second part of my original post.

If you were to ask me, a discount shopper, WHAT changes do I want to see in Big Lots so that I will want to go there more often, here's my answer:

I wish there's a small section of a steady supply of fresh fruits and vegetables, some meats, salad materials, baked goods, cookies, cheeses, dairy products, frozen items. AND, if you will add a small section with a steady supply of ORGANIC fruits and vegetables, I just might be there 2-3 times per week. So, instead of furniture and home products in front, make these be in front. Do a pilot test first in a few stores and see what kind of traffic you will get. And advertise the changes. Make sure people know that you have these now available. You just might see good results... hey you may even see better results than expected. But do the pilot test first.

Note: If you went to a Walmart superstore, if you're observant, don't you see that the most number of people who go there on a daily basis are mostly in the produce and baked goods section?
I hardly see anyone in the furniture section and home decor/products section. And if you find them there, take note of how long they stay in the furniture section versus the produce section. Don't need a master's degree to see the big difference.

Just my honest opinion. I like Big Lots! Actually, I bought the stock when I read that 2 activist investors, Macellum and Ancora, want to put their own people there. I wish them great success!

Thank you for reading!

[Jenks Jumps]

discountshopper,

I'm so glad you didn't ask to have the comment deleted. It really sparked some thought on my part.
So, I see the furniture emphasis from Big Lots as a way to differentiate itself from Walmart and Target. I'm curious, based on what you said you'd like to see the company do, why you'd rather purchase those items (especially produce) from Big Lots as opposed to Walmart or Target? Based on Big Lots' comments in the last earnings call about shrink, I'm not sure it's set up or ready to handle produce. But, like you recommend, it should perhaps consider doing a trial in a few areas and measuring results.
Thanks so much for the discussion! With this coronavirus threat, I'm even wondering when it gets to the point that there's no produce sitting out for all to touch.