Short thesis on Big Lots ($BIG)

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by howtoreadspaghetti

Disclaimer: I am short Big Lots. A small short position but a position nonetheless.

I was curious to what was happening with the company because they’re trading at a very low P/E and I figured that this may be a value stock just off of that alone but I dug into their most recent 10-K and found some thing that turned a potential long thesis into a short thesis. Why I’m short $BIG:

-Adjusted for buybacks, their capital base has grown faster than EPS and FCF. They need more money to return little to shareholders. They’ve bought back stock at aggressive paces, reducing outstanding shares by almost 50% since 2010. This move has levered the company as buybacks lower the cost of capital (to a point) but they have a lot of debt now so either they issue shares, diluting returns, or take out more debt, which is problematic in itself. More on that later. Even if you leave buybacks there and don’t add them back then you still have the same exact problem. Their capital base has grown faster than EPS and FCF growth.

-The new CEO, Bruce Thorn, recently left Mens Wearhouse and they’re getting ready to leave restructuring bankruptcy. I’m not going to throw all that blame on him as that would be unfair. The various economic headwinds that Mens Wearhouse faced due to Amazon and the like aren’t fair to throw onto a management team. But you have to look at who is running the company. That much can’t be ignored. I’m immediately raising eyebrows if a CEO left a company and that company is in financial trouble and goes to run a new company.

-Total debt has grown 14.88% while total asset have grown only 7.82% over the past ten years. DSI has grown from 60.34 days in 2017, bloating to 67.56 days in FY2019, to 63.16 days in FY2020. They make a lot of their sales from furniture and home decor, thins that people aren’t readily buying every single day so I have to keep in mind that a high DSI may be reasonable based on what they sell. But COVID has backed up supply chains for receiving furniture to sell and DSI was rising when there was a bull market. How are they going to get bad inventory off of their books now when COVID is causing closures to their stores and their supply chains? Consignment sales? Who is going to buy it? Inventory write downs? Market won’t like that. Reducing their prices? Cut their margins and the market won’t like that.

-Last year alone selling their distribution center in CA made up 53% of EBIT last fiscal year. Pull that out and EBIT and net income saw a massive decline. This isn’t the first time that selling distribution centers has made up large chunks of EBIT. You can only sell a property once so even if you’re fine with them doing that to boost EBIT you still have the problem of it being a one time event. They’ve been entering into a lot of leaseback transactions as well that I think ultimately obscure low quality earnings and cash flow. How many more properties can they sell off to boost EBIT? They have a massive store footprint already at 1,400 stores. They’re economically profitable at gross margins around 40% with little standard deviation over the past decade. They can make money in their sleep. Looking down the income statement tells you that they can’t hold onto it for long because EBIT margins don’t even outpace historical inflation rates.

-Ollie’s, their most direct competitor, has 12.2% EBIT margins. In their proxy statement’s peer compensation section their don’t see Ollie’s as part of their “peer” market though. They seem to think they compete alongside companies like Tractor Supply (8.3%), DICK’S Sporting Goods (4.3%), Advance Auto Parts (7.0%), L Brands (7.6%), Dollar General (8.3%), and Five Below (11.8%). Look at all their EBIT margins and they still fall so short of EBIT margins against their competitors. $BIG had 2.9% EBIT margin this past year. Even if I agree with them that their peer compensation review creates an accurate market for them to compete in they still, by the list they’ve created, fall far away from being peers to them in this regard.

-CA, FL, TX, and OH gave them 33% of net sales in FY2020. OH and CA just announced curfews to control COVID outbreaks and I suspect FL and TX will be forced to deal with COVID outbreaks later on in the same way. Ignoring it means more deaths and ultimately they will have to do something to curb infection rates. Big Lots aims to sell to the JCPenny demographic, the “I want more bang for my buck/I want to feel like I’m getting a deal at your expense” crowd. This crowd is hurting badly from unemployment rates being high and government financial support being low. What cash do they think their customers have to pay for furniture that they couldn’t sell when the economy was doing good? I don’t see them making those sales back soon enough to fix problems the business has. Apollo Management was aiming to take them private but the leaseback transactions that Big Lots was doing at the time of those talks made Apollo drop the idea. It seems Big Lots may be left to flounder in the public markets for a little while longer.

TL;DR: This company makes money in its sleep with high gross margins but management can’t seem to keep a lot of it in the business due to poor corporate governance. Aggressive buybacks over the past ten years has levered the company up at the worst time to be levered in 2020 and they’ve been struggling to get inventory out of their stores in good times, let alone during bad times.

This is my first short thesis. Please critique, comment, revise, insult, I don’t care. But make me better at this. I’ve been teaching myself investing for the past few years so whatever you can do to help me be better at short or long picks please let me know.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.

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