UPDATE 3-Weak Q3 view, inventory concerns weigh on Big Lots shrs

* Says higher freight costs to hurt H2 margins

* Q2 EPS cont ops $0.48 vs est $0.47; inventory up 10 pct

* Raises 2010 cont ops EPS view

* Sees Q3 EPS $0.25-$0.29 vs est $0.31

* Shrs down as much as 4 pct vs 1 pct fall in wider index (Adds details, adds analyst comments)

By Shradhha Sharma

BANGALORE, Aug 24 (Reuters) - A weak third-quarter forecast and bloated inventory pushed Big Lots Inc's (BIG.N) shares down Tuesday, despite the closeout retailer edging past Wall Street's profit expectations in the second quarter on robust sales at its furniture, home and seasonal categories.

Rising fuel and carrier rates were pushing up domestic freight costs, resulting in a hit to margins in the second half of the year, the company said.

Retailers have learnt to keep a tight lid on inventories over the last couple of years to avoid forced markdowns or deep discounts.

However, Big Lots, which stocks its stores with merchandise that has been overproduced, discontinued or rejected by other retailers, said its inventory had risen 10 percent to $734 million during the second quarter.

"The company's inventory position is much higher than what would be ideal in the current consumer environment," MKM Securities analyst Patrick McKeever said.

Big Lots, which competes with larger discounters such as Dollar General Corp (DG.N), Family Dollar Stores Inc (FDO.N) and Wal-Mart Stores Inc (WMT.N), sells everything from home appliances to toys.

"Their inventory grew twice as fast as sales in the quarter. They are planning a meaningful acceleration in sales growth in the fourth quarter, but investors are skeptical about sales acceleration in general for any company right now," Buckingham Research analyst John Zolidis said.

The company attributed the rise in inventory to a 2 percent increase in store count, early receipts of import merchandise to avoid disruptions caused by container shortages, and stocking up on furniture to boost its back-to-school sales.

However, analyst McKeever said Big Lots' decision to stock up made sense as it had made opportunistic purchases in some merchandise categories including furniture, which had done very well during the second quarter.

"If you walk into their stores, the inventory looks great. They have excellent branded closeouts in furniture, electronics etc. The quality of their merchandise is very good, and I am not so concerned about the quantity."

When manufacturers are left with extra inventory due to a discontinued line or a change in packaging requirements, they call Big Lots, which will buy the merchandise and sell it in its stores at discounted rates.

HIGHER COSTS AHEAD

On a conference call with analysts, Chief Executive Steve Fishman forecast third-quarter earnings of 25-29 cents a share, which could miss market consensus by as much as 6 cents, and said he expects a slight fall in gross margins for the rest of the year.

Higher domestic and import freight costs would offset gains that the company sees from a lower markdown rate and strong sales of higher-ticket merchandise, the CEO said.

But Columbus, Ohio-based Big Lots expects the final quarter of the year to benefit from an additional day of shopping between Thanksgiving and Christmas. [ID:nWNAB0365]

The company now sees a fourth-quarter profit of $1.41-$1.45 a share, which could also beat Wall Street expectations by as much as 6 cents.

Earlier Tuesday, Big Lots had raised its 2010 earnings forecast for the second time this year. [ID:nASA00OKL]

"Across retail, it appeared that consumers were more cautious during the June-July time frame. But it was very interesting to see that the discretionary categories and higher-ticket goods seem to be the most appealing areas of our store during the second quarter," CEO Fishman said.

Shares of the company, which have risen by a third over the last one year, were trading down $1.04 at $30.71 Tuesday afternoon on the New York Stock Exchange.

The S&P general merchandise stores index .GSPRETM was down 1 percent. (Reporting by Shradhha Sharma in Bangalore; Editing by Aradhana Aravindan and Vinu Pilakkott)