Big Lots’ (NYSE:BIG) 2Q results and updated FY12 guidance were far worse than expected and it is not surprising to see the shares trading down significantly after the earnings announcement. Reported 2Q12 EPS of $0.36 was below consensus estimates of $0.42 and also below the low end of guidance of $0.37-$0.42. Moreover, same store sales were weaker than expected and declined 1.9% as compared to consensus estimates of -0.3% and company’s guidance of “slightly negative to slightly positive”. The greatest surprise was guidance for FY12’s adjusted EPS, which was lowered significantly to $2.80 to $2.95 from $3.25 to $3.40.
While the company’s model is historically volatile, we believe increasing competitive pressures on the consumables side from Wal-Mart and dollar stores including Dollar General (NYSE: DG), Family Dollar (NYSE: FDO) and Dollar Tree (NYSE: DLTR) combined with rising discretionary pressure, and online competition from Amazon raises long term structural concerns. In addition, the company also announced several major executive changes including the departure of its CMO and a change at CFO; a transition which we believe could result in near-term disruption.
Low Consumables Mix
Big Lots’ category mix is 69.8% discretionary (including 17% furniture, 15% home, and 13% seasonal) and only 30.2% consumables. While dollar stores with high consumables mix have been performing well, a low consumable mix puts Big Lots in a tough spot given a slow recovery after recession coupled with employment concerns.
Consumables Mix
|
Big Lots |
Dollar Tree |
Family Dollar |
Dollar General |
|
30.2% |
50.8% |
66.5% |
73.2% |
While it remains a tailwind to gross margins (consumables are lower margin), it does expose the company to a higher mix of discretionary, a risk in our view given elevated unemployment levels and a reduced level of discretionary income. Going forward, we believe Big Lots is at a wrong place at a wrong time as consumers are likely to continue to shop for bargain prices and discount products.
A Brewing War in California
Currently 12% of Big Lots’ store base or 174 stores are located in the state of California.The presence of Family Dollar and Dollar General is still limited in the state.
Store Count in California
|
Big Lots |
Dollar Tree |
Family Dollar |
Dollar General |
|
174 |
363 |
20 |
11 |
However, both Family Dollar and Dollar General have announced their plans of aggressive expansion in the state. With the recent entry of these two new competitors, we expect the competition in that market to increase. In particular we believe pricing on consumables will be worth watching given a likely aggressive advertising campaign from its dollar store peers.
Unfavorable Low income consumer backdrop
With Big Lots’ average customer household income between $42,000 and $45,000, the company faces top-line pressure from an uncertain macro-economic environment particularly given its “treasure hunt” merchandising strategy. Elevated unemployment rate particularly at the High School graduate level (8.4%) is resulting in a lack of discretionary income for customers and a more need-based shopping is hurting Big Lots and favouring its competitors in dollar stores.
The company did not announce any new strategies to address the SSS and profit declines but did say that it would begin testing coolers and freezers next year. However, given the recent trends at Big Lots as compared to dollar stores, we believe bigger structural issues may be at play. Thus, we recommend avoiding this stock and look forward to dollar stores for better investment opportunities.
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