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Discount retailers are all the rage among investors as the economy slows and consumers become thriftier. And none of them has benefited more than Big Lots (BLI
), the nation's top player in the fragmented industry known as closeout retail. Big Lots buys up excess inventory on the cheap from manufacturers, typically products that have been discontinued or repackaged. Merchandise in its shops runs the gamut from vacuum cleaners and sofas to toothbrushes and blue jeans -- all selling for up to 70% less than retail prices.
It's a formula that's paying off right now: This year, the Columbus (Ohio)-based outfit has seen its share price soar more than any other major retailer. Trading at about $16, shares are up around 56% so far this year, making Big Lots one of the top performers on the New York Stock Exchange.
SO FAR, SO GOOD. While rising concerns that consumer spending is tailing off have seen the price drop somewhat in recent months, Big Lots' performance remains dramatically ahead of both the 34% fall so far this year in the Dow Jones Specialty Retailers index and the 21% drop in the Standard & Poor's 500 index.
The question now is whether Big Lots is worth its premium price. Even at today's level -- down from the 52-week high of $19.90 in June -- the stock is trading at 25 times analysts' consensus projection for next fiscal year's earnings per share of $0.63, a high valuation for a retailer in transition. Formerly known as Consolidated Stores, Big Lots still has to demonstrate that turnaround efforts started last spring can earn a long-term payoff.
"I think they've done a lot, but the stock reflects a lot of the good news," says Eric Bosshard of Midwest Research, an equity-research firm based in Cleveland. "The biggest issue is confidence in the next leg of earnings improvement."
"BACK TO BASICS." If any indication can be found in the company's two-year makeover, Big Lots may deliver. In June, 2000, chief executive Michael Potter, who has been with the company since 1991, was promoted to the top position. Under his leadership, Big Lots has returned to its roots as a closeout retailer, carving out a demographic niche just below Wal-Mart, where it appeals to consumers willing accept a product that may be somewhat less current or lower in quality if they can pay less.
Potter "is very interested in doing all of the little things required of being a successful retailer," says John Rouleau, analyst with Wachovia Securities (who does not own Big Lot shares, although Wachovia expects to receive fees for investment-banking services in the next three months). "Before [Big Lots was] involved in a couple of different concepts and had no clear focus," says Rouleau, adding: "He's getting back to basics."
Two years ago, Potter took the first step by selling the sluggish KB Toys division for $300 million, a steep discount. That resulted in a $479 million loss in the year that ended in February, 2001. On top of that, in the most recent fiscal year, which ended February, 2002, the company took a $50.4 million charge to cover the costs of dropping some product categories, updating its inventory-tracking systems, and adding to its insurance reserves. That charge, along with lackluster sales of $3.4 billion, resulted in a loss of $20.2 million, or $0.17 per share for the year.
RINGING REGISTERS. Now, early signs are that Big Lots finally may be turning around. July sales rose 16.9%, well above the 11% rise analysts had been expecting. And analysts say Big Lots recently raised earnings guidance for the fiscal year ending in February, 2003, to between $0.58 and $0.63 per share -- up substantially from the $0.50 to $0.55 per share expected a few months ago.
But keeping the momentum going will be tough. That's largely because Potter is trying to jumpstart internal growth, rather than depend on the acquisitions and new-store openings that have propelled much of the company's expansion in the past.
"The turnaround program has gotten the company out of the woods. But a lot more improvements in comparable store sales and incremental profitability are to come," says Brad McGill, analyst with Banc of America Securities. (McGill also does not own Big Lots shares, although Banc of America has received investment-banking fees from Big Lots in the last year, and is expecting additional fees in the next three months.)
SHABBY NO MORE. By the end of August, the company will have finished converting all of its closeout shops -- Odd Lots, Pick 'n Save, and others -- to the Big Lots brand, a move that saves on marketing costs. At the same time, to lure more customers, Big Lots is sprucing up its stores, which by its own admission had become shabby. "They were not as clean, well lit and well presented, and there wasn't a very complete assortment," admits Jeff Naylor, chief financial officer. "We were solely focused on price."
Big Lots believes the store spruce-up will pay off big time. Naylor says it is costing around $80,000 per store, a total of about $35 million, to convert 434 stores to the Big Lots brand, adding that the changes and improved marketing are boosting sales at the revamped stores by 5% to 6% or so. The average purchase at the revamped stores also has increased to $15, up about 6% from last year. All this, McGill says, will boost the company's operating margin, currently about 3.5%, "back toward 6% in the intermediate term and to the company's 8% target by 2005." Given the potential payoff, Naylor says the company is now considering sprucing up older Big Lots stores as well.
Meantime, the company is gaining efficiencies in other ways. For instance, it recently started using contract manufacturers to keep some 500 consumable items -- bleach, paper towels, batteries, and the like -- stocked in its stores at all times. All told, Big Lots now has key products in stock 90% of the time, up from just 50% previously. That, in turn, is improving its reputation as a "reliable place to shop," Naylor says.
AGE OF THRIFT. Big Lots also will continue to add new outlets -- 85 to 90 this year and a similar number next year -- to its current roster of 1,335 stores. "We think the market can support 2,500 stores," says Al Bell, chief administrative officer. And, of course, tougher economic times could be a plus for a deep discounter like Big Lots.
"These stores are designed for a public that likes to go bargain hunting -- and that describes just about everybody these days," says retail-industry analyst Kurt Barnard, publisher of Barnard's Retail Trend Report. If the makeover has a lasting effect, Big Lots stock may be a long-term winner.
Tsao covers financial markets for BusinessWeek Online in New York Edited by Thane Peterson
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Copyright 2002, Bloomberg L.P.
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