Big Lots' Dividend Could Be Cut as Retail Headwinds Mount
Big Lots has seen its fortunes reverse dramatically over the last two years, driven by poor capital allocation decisions and the retail sector's dynamic nature.
The discount retailer was allowed to remain open during the pandemic, resulting in the highest profit margins and earnings per share recorded by the firm in at least a decade.
Big Lots also improved its financial position near the end of 2020, sitting on about $900 million of cash compared to less than $50 million of long-term debt.
Management aggressively deployed most of the cash into ill-timed share repurchases. And the company has racked up big losses this year after buying too much inventory just as consumers shifted spending from goods to experiences and pulled back on discretionary purchases in the face of high inflation.
As of the end of July 2022, Big Lots was left with approximately $49 million of cash and just over $250 million of book debt. And analysts expect the retailer to continue racking up losses in the year ahead, resulting in a negative payout ratio.
Source: Simply Safe Dividends
Earnings reports out this week from retail bellwethers Walmart and Target painted a grim outlook for the industry, too.
While Walmart delivered better-than-expected results, this was due to the big-box retailer generating over half of its sales from grocery products.
Walmart's food sales grew at a mid-teens pace, but consumers have continued pulling back elsewhere with management calling out weakness in electronics, home, and apparel.
The grocery category is a smaller piece of Target's business. The company's poor results this week sent shares lower by more than 10% as management struck a somber tone:
"Consumers are feeling increasing levels of stress, driven by persistently high inflation, rapidly rising interest rates, and an elevated sense of uncertainty about their economic prospects. With high rates of inflation continuing to erode their purchase power, many consumers this year have relied on borrowing or dipping into their savings to manage their weekly budgets. But for many consumers, those options are starting to run out."
Target saw strength in beauty and food and beverage categories but saw spending patterns change "dramatically" in late September as higher food prices took away spending on discretionary items and even some household essentials.
Big Lots may have some appeal with increasingly cash-strapped consumers as a discount retailer. But its product mix does not look so favorable, with food accounting for less than 15% of sales. Larger categories such as seasonal merchandise and furniture may weaken further.
In light of these pressures, which could exacerbate Big Lots' deteriorating financial health and struggle to return to profitability, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.
Big Lots has a few levers it can pull to improve its liquidity and support the dividend until profitability recovers. For example, management is actively looking to sell 25 stores and could enter sale-leaseback transactions to raise upfront cash on another 25 locations.
But even if management finds ways to continue prioritizing the $35 million payout in this tough environment, Big Lots' business has stagnated for more than a decade and operates in an extremely competitive, low-margin industry even when times are good.
As conservative income investors, we would prefer to own companies with better track records of creating shareholder value and delivering profitable long-term growth. Investors who share our view may consider reviewing some of the other high dividend stocks we like here.
