Big Lots' Big Jump a Bit Much

Big-box closeout retailer Big Lots (NYSE: BIG  ) bucked a few trends upon releasing its most recent earnings last week. For one, the company posted a 30% drop in profit yet avoided a massive market sell-off. In fact, the stock went in the exact opposite direction and posted its largest one-day gain in more than 20 years. Even looking ahead, the company fell flat on first-quarter and full-year 2014 guidance. The market has been relentlessly punishing retailers for even minor misses on estimates, ignoring the effects of extreme weather and a still-tepid economic recovery, but Big Lots saw a different type of extremism. Why is the stock trading at its highs and set for more? Let's take a closer look.

Mystery
As mentioned, fourth-quarter adjusted income from continuing operations dropped 30% to $1.45 per share -- right at the midpoint of previously issued guidance and excluding a deferred tax benefit from the company's write-off of Canadian operations. Last year, management decided to wind down the Canadian business and use the freed-up cash flow for improvements in the core business.

The net loss from the Canadian business was actually much better than anticipated in the fourth quarter -- just $0.47 per share as opposed to earlier guidance of $0.65-$0.75 per share. Helping a smooth exit, the company was able to sell through more merchandise and clear out inventory, along with asset writedowns and timing of lease liability charges.

Big Lots' results could be categorized as "not awful," but is that a reason to send the stock up by nearly a quarter of its total market value?

Bright spots
It turns out investors do have a couple of reasons to rejoice. In the company's continuing operations, things look to be improving. Management forecast for current-year same-store sales to be flat or slightly positive -- an important milestone from two straight years of declines.

Since the end of February, Big Lots has officially left Canada. While the company will take a substantial charge in the current quarter, this chapter is more or less behind the company.

Domestic stores have a few good things going for them. For one, Big Lots is installing coolers and freezers in its stores to expand its food offerings. The food segment has comped up in the mid single digits lately, making it one of the company's best areas. A bonus to this is that the company is now eligible to accept food stamps -- an important, bullish distinction considering some of Big Lots' target demographics. Also coming in on a nationwide rollout is furniture financing opportunities, allowing lower-income shoppers to purchase bigger-ticket items at the stores. Food and furniture sales together account for nearly two-thirds of Big Lots' business.

For investors, the things to focus on here are cash flow and valuation. Big Lots isn't the bargain it was one week ago, and now trades at nearly 14 times forward earnings prospects. While that's not a rich figure, it eliminates much of the previously obvious discount to intrinsic value. The company expects to generate $165 million in cash flow this year, giving a P/FCF of about 13 times. Again, not particularly expensive, but also not a bargain. Big Lots appears to be stabilizing, but this isn't a story worth a premium.

While there are compelling elements to the recently improved Big Lots, investors should wait for some of this heat to come off the stock. At a lower price, the closeout retailer would be a good bet.

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