Why is Big Lots Underperforming?

It is no secret that over the past few quarters, the U.S. retail sector has been struggling to maintain sustainable growth. The reason behind this muted performance has been a combination of higher payroll taxes and weakening consumer confidence. To make matters worse, the choppy job market means less consumer spending, and this is reflected in the U.S. consumer confidence which nosedived in October.

Hence, a retailer such as Big Lots (NYSE:BIG) should ideally be able to benefit in such a scenario, but it is not. Big Lots' unique value proposition is offering products at prices less than discount retailers, and well below that of conventional retailers. The company manages to do so by purchasing products from manufacturers who intend to reduce inventory levels, thereby giving them away at lower prices.

Not impressive
Big Lots reported a year over year increase of 0.6% in net sales to $1.23 billion in the previous quarter, missing analysts' expectations by $3 million. The main reason behind this muted improvement in revenue was due to a decline in comparable-store sales, or comps, which declined 1.9%.

Big Lots has been trying to grow its top line through acquisitions. It started its Canadian operations after having completed the acquisition of Liquidation World. As a result of this, revenue from Canadian operations increased 8.2% on the back of comps growth of 8.3%. In Canada, Big Lots rebranded two stores and ended the quarter with 79 stores. Going forward, the company plans to open two new Big Lots stores in Canada. Big Lots opened 13 stores while it closed four in the U.S., ending the quarter with 1,514 stores in the U.S.

Big Lots surpassed analyst estimates on earnings, but a reduction of the full year guidance wasn't what investors were looking forward to. The company expects adjusted earnings of between $2.80 and $3.05 per share for the fiscal year, down from its earlier forecast of $2.87 to $3.12 per share. In addition, comps are expected to remain flat or drop by 1%, while net sales are expected to remain flat or increase by 1% at most.

Difficult conditions
Weak guidance from Big Lots indicates that the likes of Dollar General (NYSE:DG) and Wal-Mart (NYSE:WMT) aren't losing much business to the company. However, with the holiday season expected to be weak, as forecasted by ShopperTrak, the likes of Wal-Mart and Dollar General could face a different kind of pressure. After having witnessed a weak back-to-school season due to muted spending by consumers, higher sales during the December quarter aren't guaranteed.

Wal-Mart, the country's biggest retailer, reported lackluster quarterly results in the month of August and it expects the weakness to persist. ShopperTrak expects traffic will fall 1. 4%  during November and December, compared with a 2.5% increase in 2012. In addition, there's a shorter shopping window of 25 days as compared to 32 last year this holiday season between Black Friday and Christmas, so there will be a week less to sell.

While Wal-Mart is increasing its sales force for the holiday season by hiring 55,000 seasonal employees, the company is doing so in order to reduce the work hours. Reducing the work hours will enable Wal-Mart to save on costs, as it won't be required for the company to pay bonuses.

Wal-Mart had already dropped its expectations for the ongoing quarter in August. The fact that it is looking to hire in huge amounts for the holiday quarter to save costs rather than increase sales does not inspire confidence either.

Intense competition from Dollar General
Dollar General, which happens to be another competitor of Big Lots, has done well recently. Dollar General reported impressive same-store sales growth  of 5.1%. For 2013, management expects same-store sales growth of 4% to 5%. Total sales are expected to rise by 10% to 11% year over year in 2013. Hence, Dollar General is quite optimistic about its prospects, and its growth indicates that Big Lots isn't eating its lunch.

Dollar General's policy of introducing tobacco products has worked well. Going forward, Dollar General wants to sustain its growth momentum. It plans to open 650 new stores, up from 635 forecasted previously. In addition, it plans to remodel or relocate about 550 stores . As Dollar General opens more stores, it will increase its lead over Big Lots, leading to more difficult times for the closeout retailer.

Bottom line
Big Lots hasn't done well despite a weak economy, which should have the helped the retailer, as it sells merchandise for a lower price than dollar stores and conventional retailers. A reduced guidance is not a good sign and earnings growth is expected to be sluggish in the future. Its expected five-year earnings growth rate is 7.30%, while Dollar General's is much more impressive at 15%. So, investors would be better off investing in a company such as Dollar General than Big Lots, as the company is struggling and earnings growth won't come about easily.