Big Lots (NYSE:BIG) Surprises With Q2 Sales, Stock Jumps 13.9%

Discount retail company Big Lots (NYSE:BIG) reported Q2 FY2023 results exceeding Wall Street analysts' expectations, with revenue down 15.4% year on year to $1.14 billion. Big Lots made a GAAP loss of $249.8 million, down from its loss of $84.2 million in the same quarter last year.

Priding itself on carrying brand-name items, Big Lots (NYSE:BIG) is a discount retailer that acquires excess and overstocked inventory then sells at meaningful discounts to prices of traditional retailers

For example, if Target orders large quantities of Martha Stewart Living bath towels that don’t sell as well as expected, Target may sell those in bulk to Big Lots at pennies on the dollar rather than discount the items and try to sell them individually. This is often done to clear shelf space for new products or because of restrictions on discounting certain brands.

Big Lots’s buying approach focuses on finding excess inventory or overstocked items from other retailers, so selection can change and be varied. Shopping at Big Lots is often a treasure hunt–what the consumer loses in reliable selection is made up for with low prices. Housewares and home decor, snacks, toys and games, and furniture are key product categories at the typical Big Lots store, and brands such as Serta, Whirlpool, Kraft, Nestle, and Sony can often be found there.

The core customer is the middle class, value-conscious shopper who values a one-stop shop for most of a household’s needs but is ok with changing selection. The typical Big Lots store is mid-sized, averaging 30,000 square feet and located in suburban or urban areas shopping centers.

Broadline discount retailers understand that many shoppers love a good deal, and they focus on providing excellent value to shoppers by selling general merchandise at major discounts. They can do this because of unique purchasing, procurement, and pricing strategies that involve scouring the market for trendy goods or buying excess inventory from manufacturers and other retailers. They then turn around and sell these snacks, paper towels, toys, and myriad other products at highly enticing prices. Despite the unique draw and lure of discounts, these discount retailers must also contend with the secular headwinds of online shopping and challenged retail foot traffic in places like suburban strip malls.

Discount retail competitors include TJX (NYSE:TJX), Ollie’s Bargain Outlet (NASDAQ:OLLI), and Ross Stores (NASDAQ:ROST).

Sales Growth

Big Lots is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex high growth rates because it's growing off a smaller base than its larger counterparts.

As you can see below, the company's revenue has declined over the last four years, dropping 1.38% annually as it failed to grow its store footprint meaningfully and observed lower sales at existing, established stores.

This quarter, Big Lots's revenue fell 15.4% year on year to $1.14 billion but beat Wall Street's estimates by 3.49%. Looking ahead, Wall Street expects revenue to decline 4.87% over the next 12 months.

Number of Stores

When a retailer like Big Lots keeps its store footprint steady, it usually means that demand is stable and it's focused on improving its operational efficiency to increase profitability. Big Lots's store count shrank by 20 locations, or 1.39%, over the last 12 months to 1,420 total retail locations in the most recently reported quarter.

Taking a step back, the company has kept its physical footprint more or less flat over the last two years while other consumer retail businesses have opted for growth. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.

Same-Store Sales

A company's same-store sales growth shows the year-on-year change in sales for its brick-and-mortar stores that have been open for at least a year, give or take, and e-commerce platform. This is a key performance indicator for retailers because it measures organic growth and demand.

Big Lots's demand has been shrinking over the last eight quarters, and on average, its same-store sales have declined by 11.3% year on year. This performance is quite concerning and the company should reconsider its strategy before investing its precious capital into new store buildouts.

In the latest quarter, Big Lots's same-store sales fell 14.6% year on year. This decrease was a further deceleration from the 9.2% year-on-year decline it posted 12 months ago. We hope the business can get back on track.

Gross Margin & Pricing Power

As you can see below, Big Lots has averaged a decent 35.5% gross margin over the last eight quarters. This means the company makes $0.35 for every $1 in revenue before accounting for its operating expenses.

Big Lots's gross profit margin came in at 33% this quarter, relatively flat with the same quarter last year. This steady margin could stem from its efforts to keep prices consistently low or signal that it has stable input costs (such as freight expenses to transport goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.

This quarter, Big Lots generated an operating profit margin of negative 10.7%, down 4.4 percentage points year on year. Conversely, the company's gross margin actually increased, so we can assume that the reduction was driven by weaker cost controls or operating leverage on fixed costs.

Unprofitable publicly traded companies are few and far between in the consumer retail sector, and over the last two years, Big Lots has been one of them. Its high expenses have contributed to an average operating margin of negative 5.66%. On top of that, Big Lots's margin has declined, on average, by 9.7 percentage points year on year. Some investors were likely hoping for better results.

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

This print beat Wall Street's estimates when excluding one-time charges totaling $5.32 per share. Overall, we care more about long-range EPS growth rather than short-term movements.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.

Big Lots's free cash flow came in at $18.3 million in Q2, up 20.6% year on year. This result represents a 1.61% margin, in line with its free cash flow margin in the same period last year.

Over the last two years, Big Lots's capital-intensive business model, lack of cost discipline, and need to reinvest to stay relevant with consumers in an increasingly competitive market have drained many company resources. Its free cash flow margin has been among the worst in the consumer retail sector, averaging negative 5.43%. Big Lots's margin has also been flat. Investors are likely hoping for an inflection to positive free cash flow soon.

Return on Invested Capital (ROIC)

Big Lots's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 1.49%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.

We argue ROIC is one of the most important indicators of quality because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.

Key Takeaways from Big Lots's Q2 Results

With a market capitalization of $183.2 million, Big Lots is among smaller companies, but its more than $46 million in cash on hand and near break-even free cash flow margins puts it in a stable financial position.

This was a solid quarter for Big Lots on the back of weak peer earnings and likely low expectations. Same-store sales, revenue, and EPS (when excluding a number of one-time charges), all beat Wall Street analysts' expectations. Additionally, forward commentary was encouraging. Management stated that "we are now in a position to get back to playing offense. This will be supported by the incredible efforts of our associates, and our outstanding vendor partners, who remain aligned with our efforts to offer great quality products and amazing value. As we make further progress on our five key actions, we are optimistic that trends will continue to improve, albeit slowly, through the remainder of this year, aided by a higher penetration of bargains, more newness in our assortment, freight reductions, ongoing cost reduction and productivity efforts, more effective promotions, and a more normalized level of markdowns." Lastly, the company recently executed on sale leaseback transactions that have resulted in $300 million of proceeds, which is strengthening Big Lots's liquidity position. The stock is up 13.9% after reporting and currently trades at $7.14 per share.

Is Now The Time?

When considering an investment in Big Lots, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of Big Lots, we'll be cheering from the sidelines. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. On top of that, unfortunately its relatively low ROIC suggests suboptimal profitability prospects and its operating margins reveal poor profitability compared to other retailers.

While we've no doubt one can find things to like about Big Lots, we think there might be better opportunities in the market, and at the moment, don't see many reasons to get involved.

Wall Street analysts covering the company had a one-year price target of $6.5 per share right before these results, implying that they didn't see much short-term potential in Big Lots.

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