Big Lots Stays Neutral

We reiterate our long-term Neutral recommendation on Big Lots Inc. (BIG - Analyst Report) with a price target of $48.00 per share. The company operates as a broad line closeout retailer in the United States. The company offers food, health, beauty, plastic, paper, chemical and pet products as well as home decorative products, besides other product lines.

The Drivers

Big Lots closeout format provides it an edge over traditional discount retailers as it offers merchandise assortments to customers at very low prices. The company buys brand merchandise at lower costs from vendors who have excess inventory or have higher sales returns or discontinued products, and then resort to a fire sale of goods.

The company has been exploring numerous options to enter the Canadian turf that ended with the acquisition of Liquidation World, which operates approximately 89 stores and offers a broad assortment of closeout merchandise. Management believes the acquisition will be accretive to its top line in the coming years, and generate long-term growth prospects. The company also remains focused on enhancing its store operations capacity.

Recently, Big Lots implemented a new retail inventory system to value inventory based on the merchandise class level, instead of merchandise department level. This would help in getting a much more clear view on the profitability of merchandising initiatives undertaken. The company also hinted of focusing on new warehouse management systems, HR systems and a real estate system in the next two years.

On the store front, Big Lots opened 92 new stores in fiscal 2011, and plans to open 90outlets in fiscal 2012. The improvement in store productivity and the softening of the real estate market prompted management to enhance its store openings.

Leading to Better Results

Columbus, Ohio based company, Big Lots, posted better-than-expected fourth-quarter 2011 results. The quarterly earnings of $1.75 per share came ahead of the Zacks Consensus Estimate of $1.73. Moreover, the bottom-line results marked an increase of 19.9% from the prior-year quarter’s earnings of $1.46 per share. Excluding the Canadian operations, earnings came in at $1.83 per share.

Management now expects earnings in the range of 75 cents to 81 cents a share for the first quarter and between $3.40 and $3.50 per share for fiscal 2012.

Total revenue for the quarter increased 9.9% to $1,669.6 million, outshining the Zacks Consensus Estimate of $1,650 million.

Management now projects total U.S.sales to increase in the range of 6% to 8% for the first quarter and between 8% and 9% for fiscal 2012. Canadian sales are expected to rise in the range of $25 million to $30 million for the first quarter and between $140 million and $150 million for fiscal 2012.

Benefiting Shareholders’ too

Big Lots is actively managing its capital. The company now expects to generate cash flow of approximately $200 million in fiscal 2012. The company is also returning much of its free cash to shareholders via share repurchase.

After authorizing a share repurchase of $400 million in March 2010, Big Lots in May 2011 authorized an additional $400 million.

During the quarter under review, Big Lots spent $46 million to repurchase 1.3 million shares at an average price of $36.79 per share. In fiscal 2011, the company spent $359 million to repurchase 11 million shares at an average price of $32.79 per share. The company currently has $99 million remaining under its $400 million share repurchase program.

Sluggish Recovery and Intense Competition

The economy is not completely out of the woods, and the company’s customers remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels, and high household debt levels, which may negatively impact their disposable income, and in turn the company’s growth and profitability.

Big Lots operates in a highly competitive discount retail business, which might result in loss of market share, fall in sales and operating margins. The competitors having more stores, greater market presence, and financial resources will continue to weigh on the company’s results. Management also hinted that the gross margin for the first quarter of 2012 is expected to be marginally down compared with last year.

Closing Commentary

The pros and cons embedded in the stock advocates our long-term Neutral recommendation on the stock. Moreover, Big Lots, which competes with Target Corporation (TGT - Analyst Report) and Wal-Mart Stores Inc. (WMT - Analyst Report), holds a Zacks #3 Rank that translates into a short-term Hold rating.