Big Lots (BIG) is an interesting business, one which has seen quite a few developments taking place in recent months. I looked at the shares mid-April as the company announced a big sale-and-lease-back transaction for the four remaining distribution centers which the company owned.

I appreciated the low valuation and fact that a part of the business could thrive in this environment. I was far too conservative at the time with shares having more than doubled ever since. This move has taken place for the right reasons as the company has generated tons of cash and is solidly profitable.

Here the valuation is no longer as compelling as it was in April of course, yet I am very impressed with the operating performance.

My Past Take

When I looked at Big Lots in April I observed that the sizable sale-and-lease-back transaction would result in a big cash influx, much welcomed given the circumstances, although the company would take on some rental obligations and be hurt by some tax leakage.

A pro-forma net cash position would result in an advantage versus peers in a challenging environment as I noted that net cash balance and valuation at 6-7 times pro-forma earnings looked compelling, yet I feared large losses this year, as I anticipated quite a bit of volatility to come.

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The company sold 4 distribution centers in a massive $725 million deal, although net proceeds were pegged at just $550 million. Unfortunately, no yield/rental details in connection to the deal have been announced. As a rough estimate, I thought that yields might come in at 6-7%, thereby translating into additional rent payment of $43-50 million in exchange for $550 million in net cash proceeds.

For the year 2019, Big Lots reported a modest 1% increase in sales to $5.3 billion, with operating profits (adjusted for asset gains) reported at $156 million, down quite a bit from $219 million the year before. Reported adjusted earnings of $144 million translated into earnings of $3.67 per share, although the earnings number excluded some adjustments.

The real kicker is that a net debt load of $230 million by end of 2019 would transform into a net cash position of around $300 million following the sale-and-lease-back deal, working down to more than $7 per share. Based on the 2019 numbers, the reported earnings of $3.67 per share fell to $2.70 per share if we take out the adjustments, as incremental rental expenses (offset by reduced interest payments) made that I pegged GAAP numbers around $2 per share. Trading around the $20 mark in April, the 10 times pro-forma multiple looks very low, certainly with net cash at $7 per share, essentially valuing the operating business at 6-7 times 2019 earnings.

This looked compelling of course, yet shares have been holding up better than other retail peers and while expectations were low, that applied to pretty much all the sector. That being said, the low valuation, significant net cash and the fact that 30% of sales are tied to food and consumables looked reasonably compelling. Nonetheless, with shares having doubled from $10 to $20 in the weeks ahead of the sale-and-lease-back transaction, I was not chasing the shares after they doubled already from the lows. This came as I had quite some exposure already to the wider retail sector, as I have wrongfully underestimated to the degree to which the company would benefit from the current conditions.

Some Recent Events

Late May, Big Lots reported first-quarter results, for the three-month period ending early May. Sales rose 11% to $1.44 billion, almost entirely driven by an increase in comparable sales, up 10% on that metric. Furthermore, the company actually managed to deliver on some real operating leverage with adjusted earnings up from $0.92 per share this quarter last year to $1.26 per share in the first quarter of 2020. The company furthermore managed to cut net debt to $125 million and that is ahead of the sale-and-lease-back transaction of course, as that deal only closed mid-June.

Late June, Big Lots provided a very comforting outlook, causing shares to rise more than a quarter of their value in a tough market. Shares now trade at $43, levels last seen in the autumn of 2018. The update for the second quarter has been particularly strong as two months into the quarter, the company already feels comfortable to guide for quarterly comparable sales growth of 25-30%, actually marking acceleration from the first-quarter growth rates.

For the quarter the company now sees adjusted earnings of $2.50-2.75 per share as it is evident that the company is a prime beneficiary of current developments, with the company on track to earn close to $4 per share in the first half of the year, on top of which comes the sizable net cash position, probably close to $700 million at the moment. This comes from great current earnings and low inventory levels, as net cash now comes in close to $18 per share. This arguably made shares a steal as I misjudged the situation entirely in April, being far too conservative.

Now trading at $43, shares have more than doubled. Adjusting for net cash (adjusted for tax bills related to the sale-and-lease-back transaction) shares trade at $25, yet that is for a business earnings $4 per share in the current two quarters due to the Covid-19 pandemic and subsequent stimulus checks. At some point in time most of the hoarding will be done and actual economic hardship might kick in.

Hence, I can only conclude that I have been too cautious in April, something for which I can only blame myself, yet that is no reason to chase shares here. The company is generating tons of additional cash now, thanks to earnings and is not feeling any leverage stress, but in fact makes it a very cash-rich business. Right here and now I am sticking to a neutral position, although excessive volatility in the share price might actually provide some opportunities to step in later this year.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.