On the surface, Big Lots' (BIG -0.15%) fiscal third-quarter earnings report didn't seem to contain the ingredients to catalyze a huge share price leap. The consumer staples discount chain did report higher-than-expected earnings due to the sale of a distribution center during the quarter. But adjusting for this transaction, Big Lots' earnings improved modestly over the prior-year quarter, and fell within management's previous guidance. Nonetheless, shares soared by nearly 32% on Friday after the company filed its earnings report. Below, we'll review key highlights and uncover exactly why investors rushed to the "BIG" symbol. As we discuss the last three months, note that all comparative numbers refer to those of the prior-year quarter.
Big Lots: The headline numbers
| Metric | Q3 2019 | Q3 2018 | Change |
|---|---|---|---|
| Revenue | $1.17 billion | $1.15 billion | 1.7% |
| Net income | $126.9 million | ($6.6 million) | N/A |
| Diluted EPS | $3.25 | ($0.16) | N/A |
Data source: Big Lots. EPS = earnings per share. N/A=Not applicable; items not comparable due to a large one-time gain in the current period (discussed below).
Essential details from the quarter
- Comparable-store sales rose by 0.1%, in line with management's previous projection of "approximately flat" comps.
- The company attributed its slight revenue advance to sales growth in new stores and relocated stores, none of which are yet included in the comparable sales store base.
- Earnings surged due to the sale of Big Lots' Cucamonga, California distribution center. The sale netted an after-tax gain of $136.6 million, equal to a positive diluted per-share impact of $3.49.
- Removing this gain, and accounting for a $2.6 million, or $0.07 per-share impact of expenses from the company's ongoing "strategic business transformation," adjusted diluted loss per share of $0.18 fell within management's projected loss range of $0.15 to $0.25.
- Gross margin dipped 20 basis points to 39.7%.
- Selling and administrative expenses decreased by 60 basis points to 37.4% of sales. The cost control helped reduce the company's operating loss (adjusted for the distribution center sale) by roughly 16%, to $8.1 million.
Why Big Lots stock rocketed higher
Image source: Getty Images.
Given flat comps and adjusted earnings that didn't break out of management's forecasted range, Big Lots' stock advance was quite noteworthy. There are several reasons underlying Friday's buying interest. First, the sale of the California distribution center provided the company with net proceeds of $191 million -- a decent cash haul. Big Lots used $69 million of these funds to exercise an option to purchase its own headquarters building in a tax-deferred exchange. The deal helps defer $15 million in taxes that would have been due on the distribution center sale, and also eliminates $6 million in annual headquarters lease payments going forward. The rest of the cash windfall was used to reduce unsecured debt and to increase working capital, strengthening the company's balance sheet.
Second, Big Lots appears to be making substantial progress in its cost-cutting and productivity initiative (the so-called strategic business transformation). The organization was able to improve on its operating loss despite the $2.6 million in transformation expenses booked this quarter. On Big Lots' earnings conference call, management relayed that the company is on track to exceed a goal of realizing $100 million in annual cost savings by the end of 2020.
Investors also were impressed with the company's year-over-year inventory balance increase of 4%, to $1.1 billion. Heading into the critical holiday season, this signals management's confidence in a strong fourth quarter which should help the chain meet its full-year adjusted earnings target of $3.70 to $3.85.
Finally, these various factors underpin a growing sense that Big Lots can achieve its promise of improved performance next year, and that its stock may be currently oversold and undervalued. Before today's appreciation, the retailer's shares had lost roughly 54% of their value over the last trailing 12 months, and as of yesterday, they were trading for just five times forward one-year earnings. Following today's surge, Big Lots' stock now trades for 6.6 times forward earnings, which still appears quite inexpensive, and may look cheaper still if management can continue to execute operationally in 2020.
