Daily Letter | 1 17 April 2012Big Lots Laura Champine, CFA 212.389.8056 BUY firstname.lastname@example.orgBIG : NYSE : US$45.32 Target: US$58.00 Jason Smith 212.389.8059 email@example.comCOMPANY STATISTICS:52-week Range: 28.89 - 47.22 Consumer & Retail -- Specialty RetailMarket Cap (M): US$2,963.8Shares Out (M): 65 DEEP DIVE: WE EXPECT PRODUCTEARNINGS SUMMARY:FYE Jan 2011A 2012E 2013E INITIATIVES TO DRIVE SALESP/Sales (x):Revenue (M): 0.6x 5,202.3 0.5x 5,617.5 0.5x 5,846.8 MOMENTUM AT BIGEPS: 2.99 3.50 3.90P/E (x): 15.2x 13.0x 11.6x Investment recommendation We believe BIG’s improving product assortment will drive trafficRevenue (M): Q1 1,227.3 1,337.5 1,396.6 Q2 1,167.1 1,263.4 1,317.7 and support the company’s SSS momentum. The company Q3 1,138.3 1,226.3 1,289.3 should benefit from efforts to shift sales mix to higher-demand Q4 1,669.6 1,790.3 1,843.2Total 5,202.3 5,617.5 5,846.8 categories, broadening its selection of consumables andEPS: Q1 0.70 0.81 0.90 underpenetrated discretionary segments. At 13x our FY12 EPS Q2 0.50 0.56 0.65 Q3 0.06 0.14 0.21 estimate and 6x FY12E EV/EBITDA, we don’t believe shares fully Q4 1.75 1.99 2.15 reflect the SSS growth we are projecting in FY12 and beyond. WeTotal 2.99 3.50 3.90 believe BIG would only need to generate SSS growth in the LSDSHARE PRICE PERFORMANCE: range to achieve the significant upside potential we project. Investment highlights • We estimate BIG will generate FY12 SSS growth of 2.9% on top of +0.1%, which would be the company’s highest full-year increase since FY06. • We forecast double-digit bottom-line growth in FY12 and expect EPS to increase at a five-year CAGR of 12%. • Shares trade at only 13x our FY12 EPS estimate and 6xSource: Interactive Data Corporation FY12E EV/EBITDA. BIG trades at lower multiples than itsCOMPANY DESCRIPTION: discounter retail peers despite above-average FY12 growthBIG is the nations largest broadline closeout retailer,operating approximately 1,450 stores in the U.S. and 82 prospects.in Canada. BIG offers brand-name closeouts from over3,000 manufacturers. The product assortment includesconsumables, furniture, home furnishings, seasonal, andelectronics.All amounts in US$ unless otherwise noted.Canaccord Genuity is the global capital markets group of Canaccord Financial Inc. (CF : TSX | CF. : AIM)The recommendations and opinions expressed in this Investment Research accurately reflect the Investment Analyst’s personal,independentindependent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For importantinformation, please see the Important Disclosures section in the appendix of this document or visit Canaccord Genuity’s Online DisclosureDatabase.
Daily Letter | 2 17 April 2012WE BELIEVE AN IMPROVED ASSORTMENT WILL DRIVETRAFFIC AND SUPPORT SSS MOMENTUMIn May 2011 BIG bolstered its merchandising team by hiring Doug Wurl to serveas EVP of merchandising. Wurl brought a wealth of merchandising experience,having served as general merchandise manager of Sears’ home division for overfour years and in leadership positions at Shopko and Macy’s in the years prior.Wurl’s impact on the company’s merchandising strategies and productassortment can already be seen in his short time as GMM. Since his arrival, BIGhas taken a more aggressive approach to its closeout strategy, which has enabledit to broaden its product assortment, specifically in consumables. According tomanagement, Wurl has been able to garner better deals from vendors on a more-consistent basis than the company had in the past. BIG has also added moreupscale vendors to its roster and has expanded the breadth of its global sourcing.BIG has become more competitive in its pricing strategy, which we believe willcontinue to drive traffic as budget-conscious shoppers seek out values. Additionalchanges include a narrower focus on the merchandising schedule, with planningthroughout the year now completed in nine-week increments, similar to how thecompany had previously planned for its Christmas assortment.The consumables segment is BIG’s largest product category, accounting for 31%of total sales. BIG continued to improve its product assortment throughout FY11,specifically adding a more consistent mix of consumables. BIG has expanded itsconsumables assortment to include more gourmet and specialty items. BIG hasalso heightened its focused on improving marketing and in-store execution,including more prevalent signage and the addition of the “Wall of Values” whichhighlights deals within consumables. Closeout remains the focus withinconsumables, making up about 70%-80% on average of the total assortment. BIGhas broadened its SKU base, which we believe will add some stability in thecategory. Management commented that an expanded selection of gourmetproducts and European imports have been well received by consumers. TheFresh Finds captive label program was expanded in Q3, and it continues toresonate with customers. BIG’s captive label brands are developed jointly withvarious domestic and overseas manufacturers, using a well-respected third partyto help develop the line. BIG has been able to generate brand identity and as aresult pricing power with some of its captive label products. Sales trendsimproved in the consumables category in FY11, with comparable sales up in themid- to high-single-digit range in the final three quarters of the year. We believean improved consumables assortment was largely responsible for BIG’s SSSrecovery in H2/11. We expect a broader mix of basics and the addition ofspecialty items and more captive label brands to drive traffic into stores in 2012.
Daily Letter | 3 17 April 2012 Figure 1: An improved consumables assortment helped generate SSS momentum in FY11 Q1:11 Q2:11 Q3:11 Q4:11 Consumables yr./yr. growth 3.7% 8.2% 11.4% 9.5% SSS -3.6% -1.5% 1.7% 3.4% Source: Company reportsBIG should benefit from an improved product mix within its discretionaryassortment as well. The company has shifted its product mix away from appareland its traditional toy business, increasing inventory and allocating more floorspace to better-performing categories. BIG offered a larger seasonal assortment inQ4, adding square footage to display trees and trim. This resulted in acomparable sales increase in the low double digits for the category. We believethe seasonal business sustained momentum in Q1, boosted by warmer weatherand a high-quality product assortment that will resonate with shoppers. Theseasonal business faces an easy Q1 comparison as difficult weather resulted in DDcomparable sales declines in northern regions of the country in FY11.The company is in the process of completing the expansion of its home business,specifically adding floor space for merchandise such as bedding and table topitems to better leverage the strength of its furniture business. Managementexpects sales growth within the category to accelerate as FY12 progresses. Ourrecent store checks revealed an attractive assortment of seasonal and homeinventory. It is notable the company’s new GMM has a wealth of experience inhome, and we believe he has brought in buyers with whom he has worked in thepast.Electronics is a category BIG believes can excel beyond a seasonal business andbe a full-year growth driver. Electronics turned in a strong performance in Q4with comparable sales up nearly 20%, and management commented on the latestconference call that sales momentum has continued in Q1. We believe BIG willbenefit from an increased inventory of popular products such as tablets, chargers,headphones and ear-buds, flash drives and memory cards, MP3 players, phoneand tablet covers as well as other accessories for mobile devices. The focus herewill be on low-end and discount models that will likely appeal to BIG shoppers.The company has not significantly expanded floor space for electronics, but themerchandise is receiving greater exposure in stores. As small items are taking theplace of TVs, the company can significantly improve SKU range without needingto take square footage from other categories.
Daily Letter | 4 17 April 2012 Figure 2: FY11 sales mix by product category Play n Wear Consumables 15% 31% Seasonal 13% Hardlines & Other 8% Home 16% Furniture 17% Category Products Consumables Food, health, beauty, plastics, paper, and pet Furniture Upholstery, mattresses, ready-to-assemble and case goods Home Domestics, stationary, and home decorative Play n Wear Electronics, toys, jewelery, infant, and apparel Seasonal Lawn and garden, Christmas, and summer assortments Hardlines & Other Appliances, tools, and home maintenance Source: Company reports, Canaccord GenuityWe expect BIG will generate more-consistent SSS growth in FY12. Our Q1estimate calls for SSS growth of 4% on top of -3.6%. Management guided for Q1SSS to be up 2%-4%, and the consensus estimate is 2.7%. For FY12, we forecast aSSS increase of 2.9% on top of +0.1%, which is a 40bps improvement in the two-year stacked SSS trend. This is at the high end of management’s guidance rangeof +2% to +3% and would represent BIG’s largest full-year SSS gain since FY06.
Daily Letter | 5 17 April 2012 Figure 3: We estimate BIG will generate consistent SSS growth in FY12 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Q1:07 Q1:08 Q1:09 Q1:10 Q1:11 Q1:12E Yr./yr. SSS growth Source: Company reports, Canaccord GenuityWE FORECAST A GROSS MARGIN RECOVERY IN H2/12BIG’s gross margin contracted 85bps in FY11, largely the result of morecompetitive pricing and the shift in sales mix to lower-margin consumableproducts. We believe consumables are in higher demand and turn faster in stores,which should translate to increased levels of store traffic as the assortmentimproves. The shift in mix within the discretionary businesses should help boostprofit given the higher-margin nature of the home and furniture businesses.Lower markdown activity should also help drive margin expansion. Warmerweather should result in improved pricing yr./yr. within seasonal in H1, whileBIG plans to lessen its reliance on the segment in Q3, given the high level ofmarkdowns that were necessary in the October quarter in FY11. We forecastgross margin expansion of 60bps in H2/12 as an improved product assortmentsupports SSS gains and BIG begins to lap a period of higher markdown activity.We estimate BIG’s gross margin will expand 10bps in FY12 and increase 10bps-15bps annually in FY13-FY16.WE ESTIMATE DOUBLE-DIGIT EPS GROWTH IN FY12 ANDBEYONDOur Q1 forecast calls for operating EPS of $0.81, at the high end of management’sguidance range of $0.75-$0.81 and $0.02 above consensus. We project grossmargin contraction of 55bps in Q1 as a result of the continued shift in mix tolower-margin consumables and more-competitive pricing. We forecast a flatSG&A expense rate with leverage on 4% SSS growth offset by higher depreciation
Daily Letter | 6 17 April 2012and incentive costs. For FY12, we estimate EPS of $3.50. FY12 guidance is $3.40-$3.50, and the consensus estimate is $3.50 with a lower implied share countversus our model adding $0.04. We are projecting EPS to increase at a five-yearCAGR of 12%.CANADA APPEARS TO BE IMPROVING, BUT IT IS STILL INTHE EARLY STAGES OF ITS TURNAROUNDIn mid-2011 BIG completed the $20MM acquisition of Liquidation World, an 89-store closeout franchise in Canada. Our initial visit to three LW locations inCalgary shortly after the acquisition revealed obscure locations, dated buildings,and sparse inventory excluding a solid furniture assortment. BIG closed sevenlocations and invested $46MM in the Canadian business over H2:11 to buildinventory, staff operations, and refurbish store locations. Q4 sales of $37MMcame in $7MM above the high end of guidance, which management credited to astrong initial response to the introduction of new products and categories withinstores. We view this as a positive sign given the limited assortment availablethrough much of the quarter. Inventory ended FY11 at $22MM, and managementplans to sustain levels in the $25MM to $30MM range. BIG expects to reach thislevel by Q2, but adjustments to product assortment will continue through Q3.Similar to the U.S., we expect BIG to shift its product mix to more in-demanditems. This translates to a broader assortment of consumables, which we believewill be a healthy traffic driver. The Canadian operations will not likely seesignificant marketing support in FY12 as BIG is focused on testing store executiononce shelves are fully stocked before launching any sizable marketing agenda.For FY12 BIG guided for sales in Canada of $140MM-$150MM, up from $60MMover seven months in FY11. Guidance calls for the Canadian operations to be adrag on EPS of $0.21-$0.26 as BIG continues to build up inventory, recruit talent,and refurbish stores. Management indicated it was close to hiring a headmerchant, which would largely complete the initial phase of its staffing efforts.Sales dollars are expected to increase and operating losses to decline sequentiallythroughout FY12 as inventory levels improve. BIG is targeting a breakevenbottom line by FY13.BIG TRADES AT ATTRACTIVE MULTIPLES COMPARED WITHITS DISCOUNT RETAIL PEERSWe believe shares of BIG are currently undervalued, trading at approximately a20% discount to peers. We think this discount is based on BIG’s inconsistent salestrends and expect the gap to close as the company reports improved SSS growthin 2012. Based on our FY12 EPS estimates, shares trade at 13x EPS and 6xEV/EBITDA, below the peer averages of 16x and 8x, respectively. We don’tbelieve the discount is warranted given our forecast for above-average growth inEPS.
Daily Letter | 7 17 April 2012Figure 4: Shares trade below the peer group’s average CY12E CY12E CY12 Sales CY12 EPS Discount retailers P/E EV/EBITDA Growth Growth Big Lots 13x 6.1x 8% 17% Dollar General* 17x 9.1x 8% 16% Dollar Tree 20x 10.4x 12% 21% Family Dollar 17x 8.3x 9% 18% Freds* 15x 5.6x 5% 15% Ross Stores 18x 9.1x 8% 16% Target* 14x 7.4x 5% 0% TJX Companies 18x 9.2x 7% 17% Wal-Mart* 13x 7.2x 6% 8% Average 16x 8.1x 8% 14% *Based on consensus estimatesSource: Canaccord Genuity, Thomson Reuters OUR DCF ANALYSIS INDICATES POTENTIAL FOR FURTHER SHARE-PRICE GAINS On our FY12 estimates, BIG shares currently trade at 11x FY12 EV/NOPAT, but our model suggests the stock should trade at a 14x multiple. This suggests BIG holds potential upside of over 25% in the next 12 months.
Daily Letter | 8 17 April 2012Figure 5: Our discounted NOPAT model implies potential upside of over 25% Discount rate 10% Annual NOPAT Growth 4% Year 1 2 3 4 5 6 7 8 9 10 11 NOPAT 267 293 322 350 379 394 410 426 443 461 461 Y/Y growth 10% 10% 9% 8% 4% 4% 4% 4% 4% 0% PV of NOPAT 242 240 239 236 231 217 205 193 182 171 171 Sum of PVs 2,156 Terminal multiple 10 (Implies no growth beyond terminal year) Terminal value (PV) 1,647 Enterprise value 3,803 Implied multiple 14x Actual multiple 11x Potential Actual Implied Upside FY11E NOPAT 267 267 Multiple 11x 14x Enterprise value 2,961 3,803 Plus: cash 69 69 Less: debt (66) (66) Equity value 2,964 3,806 Shares o/s 65 65 Value per share $45.32 $58.19 28%Source: Canaccord Genuity
Daily Letter | 10 17 April 2012ValuationOur PT of $58 is based on our discounted NOPAT model. Shares currently trade ata FY12E EV/NOPAT multiple of 11x. Our model suggests BIG should trade at amultiple of 14x. Assuming shares approach their intrinsic value over the next 12months, BIG offers potential upside of over 25% over its current price. Based onour FY12 estimates, shares currently trade at 13x EPS and 6x EV/EBITDA. OurPT implies multiples of 17x and 8x, respectively.Investment risksA slowdown in sales stemming from a product assortment that does not resonatewith shoppers would pose a risk to our projections. Macroeconomic factors andextreme weather could also impact sales trends. Rising cost pressures couldimpact margins. The LW acquisition could require a greater capital investment torefurbish stores and replenish inventories than management anticipates.
Daily Letter | 11 17 April 2012APPENDIX: IMPORTANT DISCLOSURESAnalyst Certification: Each authoring analyst of Canaccord Genuity whose name appears on the front page of this investment research hereby certifies that (i) the recommendations and opinions expressed in this investment research accurately reflect the authoring analyst’s personal, independent and objective views about any and all of the designated investments or relevant issuers discussed herein that are within such authoring analyst’s coverage universe and (ii) no part of the authoring analyst’s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the authoring analyst in the investment research.Site Visit: An analyst has visited the issuers material operations in Columbus, Ohio. No payment or reimbursement was received from the issuer for the related travel costs.Price Chart:*Distribution of Ratings: Coverage UniverseGlobal Stock Ratings IB Clients(as of 2 April 2012) Rating # % % Buy 503 59.3% 31.0% Speculative Buy 91 10.7% 73.6% Hold 232 27.4% 18.5% Sell 22 2.6% 9.1% 848 100%Canaccord Ratings BUY: The stock is expected to generate risk-adjusted returns of over 10% during the next 12 months.System: HOLD: The stock is expected to generate risk-adjusted returns of 0-10% during the next 12 months. SELL: The stock is expected to generate negative risk-adjusted returns during the next 12 months. NOT RATED: Canaccord Genuity does not provide research coverage of the relevant issuer. “Risk-adjusted return” refers to the expected return in relation to the amount of risk associated with the designated investment or the relevant issuer.Risk Qualifier: SPECULATIVE: Stocks bear significantly higher risk that typically cannot be valued by normal fundamental criteria. Investments in the stock may result in material loss.
Daily Letter | 12 17 April 2012Canaccord Research Disclosures as of 17 April 2012 Company Disclosure Big Lots 5, 7 1 The relevant issuer currently is, or in the past 12 months was, a client of Canaccord Genuity or its affiliated companies. During this period, Canaccord Genuity or its affiliated companies provided the following services to the relevant issuer: A. investment banking services. B. non-investment banking securities-related services. C. non-securities related services. 2 In the past 12 months, Canaccord Genuity or its affiliated companies have received compensation for Corporate Finance/Investment Banking services from the relevant issuer. 3 In the past 12 months, Canaccord Genuity or any of its affiliated companies have been lead manager, co-lead manager or co-manager of a public offering of securities of the relevant issuer or any publicly disclosed offer of securities of the relevant issuer or in any related derivatives. 4 Canaccord Genuity acts as corporate broker for the relevant issuer and/or Canaccord Genuity or any of its affiliated companies may have an agreement with the relevant issuer relating to the provision of Corporate Finance/Investment Banking services. 5 Canaccord Genuity or any of its affiliated companies is a market maker or liquidity provider in the securities of the relevant issuer or in any related derivatives. 6 In the past 12 months, Canaccord Genuity, its partners, affiliated companies, officers or directors, or any authoring analyst involved in the preparation of this investment research has provided services to the relevant issuer for remuneration, other than normal course investment advisory or trade execution services. 7 Canaccord Genuity intends to seek or expects to receive compensation for Corporate Finance/Investment Banking services from the relevant issuer in the next six months. 8 The authoring analyst, a member of the authoring analyst’s household, or any individual directly involved in the preparation of this investment research, has a long position in the shares or derivatives, or has any other financial interest in the relevant issuer, the value of which increases as the value of the underlying equity increases. 9 The authoring analyst, a member of the authoring analyst’s household, or any individual directly involved in the preparation of this investment research, has a short position in the shares or derivatives, or has any other financial interest in the relevant issuer, the value of which increases as the value of the underlying equity decreases. 10 Those persons identified as the author(s) of this investment research, or any individual involved in the preparation of this investment research, have purchased/received shares in the relevant issuer prior to a public offering of those shares, and such person’s name and details are disclosed above. 11 A partner, director, officer, employee or agent of Canaccord Genuity and its affiliated companies, or a member of his/her household, is an officer, or director, or serves as an advisor or board member of the relevant issuer and/or one of its subsidiaries, and such person’s name is disclosed above. 12 As of the month end immediately preceding the date of publication of this investment research, or the prior month end if publication is within 10 days following a month end, Canaccord Genuity or its affiliate companies, in the aggregate, beneficially owned 1% or more of any class of the total issued share capital or other common equity securities of the relevant issuer or held any other financial interests in the relevant issuer which are significant in relation to the investment research (as disclosed above). 13 As of the month end immediately preceding the date of publication of this investment research, or the prior month end if publication is within 10 days following a month end, the relevant issuer owned 1% or more of any class of the total issued share capital in Canaccord Genuity or any of its affiliated companies. 14 Other specific disclosures as described above. Canaccord Genuity is the business name used by certain subsidiaries of Canaccord Financial Inc., including Canaccord Genuity Inc., Canaccord Genuity Limited, Canaccord Genuity Securities LLC, and Canaccord Genuity Corp. The authoring analysts who are responsible for the preparation of this investment research are employed by Canaccord Genuity Corp. a Canadian broker-dealer with principal offices located in Vancouver, Calgary, Toronto, Montreal, or Canaccord Genuity Inc., a US broker-dealer with principal offices located in Boston, New York, San Francisco and Houston or Canaccord Genuity Securities LLC, a US broker-dealer with principal offices located in New York or Canaccord Genuity Limited., a UK broker-dealer with principal offices located in London and Edinburgh (UK). In the event that this is compendium investment research (covering six or more relevant issuers), Canaccord Genuity and its affiliated companies may choose to provide specific disclosures of the subject companies by
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