Big Lots in Neutral Lane

Big Lots Inc.’s (BIG) closeout format provides it an edge over traditional discount retailers as it offers merchandise assortments to customers at extremely lower prices. The company buys brand merchandise at lower costs from vendors, who have excess inventory and resort to a fire sale of their goods, higher sales returns or discontinued products.

The company’s business model is gaining strength. Big Lots’ second-quarter 2010 earnings of 48 cents a share outshined the Zacks Consensus Estimate by a penny, and soared 37.1% from 35 cents posted in the prior-year quarter on the heels of healthy sales.

The better-than-expected results prompted management to raise its earnings outlook. Big Lots now expects fiscal 2010 earnings in the range of $2.82 to $2.90 per share, up from its previous guidance range of $2.75 to $2.85, and reflects a 19% to 22% growth over $2.37 earned in fiscal 2009.

Big Lots has also been quite proactive in managing its capital. The company now expects to generate cash flow of approximately $220 million in fiscal year 2010. The company is also returning much of its free cash to shareholders via share repurchase.

However, Big Lots, which operates in a highly competitive discount retail business, faces stiff competition. This may result in loss of market share and a dip in sales and operating margins. The competitors having larger number of stores, greater market presence, and financial resources will supersede Big Lots.

Moreover, the company’s customers remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels, and high household debt levels, which may negatively impact their discretionary spending, and in turn, the company’s growth and profitability. Much of the company’s merchandise assortments are discretionary in nature.

Given the pros and cons, we prefer a Neutral rating on the stock with a target price of $33.00. Moreover, our Zacks #3 Rank, which translates into a short-term ‘Hold’ rating, correlates with our long-term recommendation.

BIG LOTS INC (BIG): Free Stock Analysis Report

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