Big Lots (BIG) had a pleasant surprise at hand for investors ahead of the Eastern weekend as it announced a massive sale-and-lease-back transaction for its four remaining distribution centers. The company will see huge proceeds from the deal, although accompanied by some tax leakage as well, creating a strong net cash position on the balance sheet, needed with a real storm on the horizon for Big Lots, just like the rest of the economy.

A Quick Update

Big Lots has reached a deal with Oak Street Real Estate Capital to sell 4 distribution centers in a deal which is valued at $725 million, although net proceeds after taxes and other transaction costs only come in at $550 million.

The company aims to take advantage of the additional flexibility from the cash influx, and might use part of the proceeds to buy back debt, hold additional cash and even engage in some share repurchases at current low levels.

Based on the 2018 annual report, it becomes clear that these warehouses measure about 7.5 million square feet and serve over 1,000 stores, making them a critical part of the operations of Big Lots.

A bit unfortunate is that the company has not provided any details about the rent which the company will be paying. Assuming about a 6-7% yield, that suggests Big Lots will see $43-50 million in annual additional rent payments, in exchange for the $550 million in net proceeds.

Note that the company already sold its fifth distribution center in California last year for net after-tax proceeds of $90 million, although that deal was complicated as it involved a large exercise option as well.

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Some Modeling

Late February, Big lots reported its 2019 results with full-year revenues up little over a percent to $5.3 billion. Excluding the gain reported on the sale of the Californian distribution center, the company reported operating profits of $156 million, down from $219 million a year before.

The company did report adjusted earnings per share of $3.67 per share, or $144 million, although the company furthermore made some other adjustments to the earnings numbers other than the gain on the distribution center in California. These adjustments combined totaled nearly $50 million on a pre-tax basis, mostly relating to restructuring charges.

The company ended 2019 with $53 million in cash and equivalents and $279 million in debt. Hence, the company operates with roughly $230 million in net debt as this could transform into a net cash position of around $300 million following the latest deal, actually working down to about $7 per share!

Knowing the company pays about $15 million in interest on its gross debt, these expenses can be forfeited and in fact that company might earn a few million on the net cash position in interest income. This makes for net $20 million in incremental revenues or better said reduced expenses, if not for the fact that I estimate that additional rent expenses run at $43-50 million. Overall, the deal might hurt the bottom line by about $23-30 million, that is on a pre-tax basis.

So let’s think of this for a moment. The company reported adjusted earnings of $3.67 per share in 2019 and even if we back out the adjustments (other than the gain on the sale of the Californian distribution center) earnings came in around $2.70 per share. The $23-30 million pre-tax net detrimental effect of the sale and lease-back of the other distribution centers works down to about $18-24 million after taxes. This makes that earnings would likely fall to $2 per share.

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Some Further Thoughts

Big Lots is a bit of a special case as its share peaked at $60 early in 2018, with shares having fallen toward the $20 mark late 2019 already. Shares rebounded to the $30 mark in January, before falling to just $10 during the March turmoil and now trade at $20. This marks some relative outperformance vs. other players in the wider retail sector, although the wider sector has seen real differentiation between returns of grocery plays, mass merchandise retailers, among others.

Based on the net cash position, shares trade at 6-7 times earnings reported in 2019, that is pro-forma after backing out adjustments made to earnings last year and incorporating additional rent expenses.

While this arguably looks very cheap, so does the rest of the sector look like although the very strong balance sheet is somewhat of a stand-out compared to peers. While it is good that the company has a decent presence to food and consumables at roughly 30% of sales, other categories of Big Lots are less relevant in today’s environment.

The move made by management, that of engaging in a large sale-and-lease-back transaction, was requested by activist investors, who called for a major share buyback program as well. While the company has pulled off all the tricks and this has provided a short-term bump to the share price, it has saddled the company with long-term rent obligations as well, yet provided a great liquidity influx, just when the company finds itself in a very tough operating environment already.

Hence, I am attracted to the story and the situation. On the negative side, the company is hurt hard just like the rest of the industry, margins are very low and the company undoubtedly will report huge losses in 2020. The good news is that the company has a very strong balance sheet, including a substantial net cash position, as this results in strong position vs. more challenged peers with weaker balance sheets.

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I look forward to taking advantage of anticipated excess volatility in the weeks from now, yet I am not compelled to buy the shares here at $20 after they have just doubled and operating assets have increased from about $3 to $13 along the way.

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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.