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Is Big Lots a Big Buy?

By Brian D. Pacampara, CFA - Apr 22, 2016 at 6:35PM

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Shares of the closeout retailer on fire, but how much room is left to run?

Shares of Big Lots (BIG -3.17%) have been on a white-hot run of late, up about 30% over the past three months. That easily outpaces the S&P 500, as well as discount retail peers like Dollar General and Wal-Mart. Signs of a sales turnaround and optimism over finally entering the digital age are fueling the happy times for Big Lots shareholders, but how long can they last? 

Image source: YCharts.

Turnaround tale
Operationally, Big Lots shareholders have reason to be optimistic. In Q4, same-store sales increased 70 basis points -- representing the eighth straight quarter of growth -- while gross margin inched up to 40.9%, which was 10 basis points higher than the year-ago period. Operating margin also came in at a solid 9.5%, suggesting that management isn't just deep-discounting their way to improved comps.

Big Lots' turnaround initiatives, which include the introduction of a furniture leasing program, a change to its merchandising mix, and the continued right-sizing of its store count, have all seemed to help sales without weighing too heavily on profitability. No small feat, indeed. Management even upped the quarterly dividend 11% to $0.21 per share, showing plenty of confidence in the company's growth trajectory going forward. For Q1, Big Lots expects a same-store sales increase in the low single-digit range.

When you combine that upbeat near-term outlook with the long overdue launch of an e-commerce platform (which should help boost longer-range sales), it's no surprise that Mr. Market is big on Big Lots' prospects. As a Foolish value investor, however, I worry that he might be a little too excited.

Image source: Big Lots

Too much credit?
Without a clearly differentiated offering, it's tough to see how Big Lots keeps the momentum up in such a notoriously competitive space. After all, as fellow Fool Demitrios Kalogeropoulos notes, same-store sales declined for 10 consecutive quarters prior to the recent string of increases. While aggressive merchandise changes are certainly having a positive effect, the novelty might fade over time with fickle customers. And since the gains related to Big Lots' furniture leasing program are heavily credit-driven, they may not be all that sustainable, either. In other words, there's a decent chance that the company's recent sales improvement is somewhat temporary in nature.

On the digital side, Big Lots itself doesn't expect too big of an initial boost: CEO David Campisi says it only sees the website generating $20 million in sales this year, which pales in comparison to a top line of $5.2 billion. As Demitrios points out, Big Lots has its work cut out in the e-commerce game against rivals with a multiyear head start. The platform probably won't be profitable for several quarters, and may even cannibalize business from customers who enjoy Big Lots' in-store experience.

Waiting for a discount
With all that said, it wouldn't shock me if management keeps the sales momentum up for several more quarters. Given the recent-run up and P/E in the high teens, however, Big Lots shares don't seem to be factoring in enough risk that it doesn't. For reference, you can pick up dividend stalwart Wal-Mart at a P/E of 15, or pay up a bit for the faster-growing Dollar General at a P/E of 20. With year-over-year comparisons only about to get tougher for Big Lots in upcoming quarters, a more attractive entry point may be ahead. 

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