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We recently upgraded our recommendation on Big Lots Inc. (BIG - Analyst Report) to Neutral following better-than-expected third-quarter 2012 bottom-line results and an upbeat outlook, with a price target of $30.00. Earlier, we had an Underperform view on the stock.

The company posted third-quarter 2012 adjusted loss of 10 cents per share compared with adjusted earnings of 6 cents in the comparable prior-year period. However, the reported loss per share compared favorably with the Zacks Consensus Estimate of a loss of 24 cents, and fared better than the company’s projected loss of 20 cents – 30 cents per share.

On a consolidated basis, the company now expects adjusted earnings in the range of $2.86–$3.05 per share for fiscal 2012. Earlier, the company had forecasted consolidated earnings between $2.80 and $2.95 per share. For its U.S. operations, adjusted earnings are forecasted to be in the range of $3.12 – $3.27 per share.

The Zacks Consensus Estimates have been portraying an uptrend following a narrower-than-anticipated Q3 loss. The Zacks Consensus Estimates for fiscal 2012 and 2013 increased 11 cents and 5 cents to $2.91 and $3.13, respectively, in the last 30 days.         

On the valuation front, the stock looks attractive, signifying adequate upside potential in the stock. Big Lots currently trades at a forward P/E of 9.8x, reflecting a discount of 36% to the peer group average of 15.4x. Again, its price-to-book ratio of 2.7 is at a substantial discount to the peer group average of 4.2.

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

However, the stock’s top-line performance that missed Zacks’ expectation and the contraction in margin keeps us on the sidelines.

Total revenue fell marginally by 0.4% to $1,134.2 million during the quarter, and also missed the Zacks Consensus Estimate of $1,139 million. Net sales for U.S. operations decreased 1.9%, reflecting a 4.6% decline in comparable-store sales. U.S. comparable-store sales are now expected to drop in the low-to-mid single digit range during the fourth quarter and low single digit range during fiscal 2012.

Gross profit for the third quarter decreased 2.6% year over year to $432.6 million, whereas gross margin contracted 90 basis points to 38.1%. The contraction in gross margin was due to increased markdowns in discretionary categories and better performance of lower margin carrying categories, such as Electronics and Consumables, when compared with higher margin discretionary categories.

The above analysis advocates our Neutral stance on the stock. Big Lots, which competes with Target Corporation (TGT - Analyst Report), holds a Zacks #3 Rank that translates into a short-term “Hold” rating.

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