Big Lots: the Little Discount Store that Could

Recent trends in retail have been very good to Big Lots (NYSE: BIG). The modest discounter has become a favorite with Millennials, Mr. Market and value investors.

Revenues at the clearance-oriented store went up by $29 million during the first quarter of 2016. Ycharts data indicates that Big Lots reported a TTM revenue of $5.191 billion for fourth quarter 2015, and $5.223 billion for first quarter 2016. It looks as if Big Lots is bucking industry trends that have led to falling sales at Target (NYSE: TGT).

The revenue growth was reflected in a modest net income increase. The net income rose from $142.87 million in January 2016 to $149.32 million in April. That gave Big Lots a profit margin of 2.95% and a free cash flow of $78.61 million.

Does Big Lots Make Money?

These numbers are an indication of very low margins which will have many value investors asking if Big Lots makes money. The answer to that question is sort of; Big Lots makes money, but it has very little float.

Big Lots reported $333.44 million in cash from operations on April 30, down slightly from $342.35 million in January 2016. That was an improvement over April 2015 when the chain made $303.92 million in cash from operations.

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A more bothersome figure was cash and short-term investments. Big Lots only had $64.39 million in the bank on April 30. That number was up from $54.14 million in January; but it was still lower than the $67.19 million the retailer had in the bank in April 2015.

This figure is bothersome because Big Lots reported total liabilities of $986.55 million; and a long term debt of $153.8 million, on April 30, 2016. It looks as if this retailer is closer to the death spiral than you might think. It has very little cash on hand, making Big Lots vulnerable to a sudden collapse.

Is Big Lots Worth the Share Price?

So yes, Big Lots makes money, but it is not a stock for the faint of heart. The risks this retailer is taking are great and the rewards are dubious. Yet it is easy to see why some investors like Big Lots. The chain delivered a dividend yield of 1.47% and a return on equity of 21.88% on April 30.

Unfortunately much of that share-price increase came from a burst of buying; that looks suspiciously like traders trying to short the stock. As recently as May 23, 2016, Big Lots was trading at $41.99 a share but the price shot up to $53.08 by June 3, largely because of positive media coverage.

That price is not justified because the low amount of float that Big Lots has. The company is simply too risky to be considered a value investment, and it might not be a growth stock either.

What is Big Lots Anyway?

Big Lots is a hard company to understand, because it does not fit into normal categories. It is a discounter, but it is not a dollar store like Dollar General (NYSE: DG); nor is it a big box retailer like Target.

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Big Lots sells a mixture of close-out merchandise; stuff that other retailers could not sell, and new goods. This mixture of goods includes everything from potato chips to furniture. A good way to think of Big Lots is as a brick and mortar version of Overstock.com (NASDAQ: OSTK). Like Overstock, Big Lots specialty is selling what others cannot move.

This gives Big Lots a sort of cult following; because it often offers a higher quality of merchandise and a greater selection than dollar stores. That attracts a slightly more affluent and sophisticated class of shopper; similar to Target’s.

Big Lots keeps expenses low by selectively locating stores in cheaper neighborhoods and limiting its footprint in markets. The company is also very good about locating stores in a certain kind of region; usually an urban area with a large working class and a lot of young singles.

Big Lots Cashes in on the Millennials

The selective geography; and unique merchandise, has made Big Lots a big favorite of Millennials and Hipsters. That’s a huge advantage because Millennials are now America’s largest generation. The 75.4 million Millennials; people under 35, now outnumber the 74.9 million Baby Boomers.

Big Lots is well positioned to take advantage of that growing demographic with 1,460 stores in the United States. It is also a chain that is in no hurry to grow; Big Lots closed more stores than it opened in 2015. For the record, Big Lots shuttered 20 locations and opened nine stores last year.

The chain also has some unique features that make it less vulnerable to Amazon than other discounters. It operates in urban areas, and has a lot of working class customers that are less likely to shop online. Big Lots also sells some merchandise that might not be available at Amazon.

Big Lots vs. Overstock.com

Interestingly enough the biggest threat to Big Lots, could be Overstock.com; which can be considered Big Lots’ closest competitor. Like Big Lots, Overstock has seen steady revenue growth in recent years. The online close out store’s revenue grew from $1.554 billion in March 2015 to $1.673 billion in March 2016.

Shoppers check out the offerings at Big Lots at Manor Shopping Center.
Shoppers check out the offerings at Big Lots at Manor Shopping Center.

Overstock has some serious weaknesses including a much lower cash flow; it reported making just $63.1 million in cash from operations on March 31, 2016. The online close out store also reported a negative free cash flow of -$54.1 million, and a net income of just $13.14 million.

These figures; like those at Big Lots, indicate that the close-out business is a risky one characterized by low cash flows and operating margins. Overstock did have more cash in the bank than Big Lots; $128.19 million on March 31, but less cash flow.

The numbers reveal that close-out retail is not a widows and orphans investment. Even though they are popular with consumers, these outlets simply do not generate enough cash to be a safe investment. Value and long-term investors need to stay away from both Big Lots and Overstock.com, because either of these retailers could collapse at almost any time.