TEXT-S&P revises Big Lots outlook to stable from negative
Overview -- We believe U.S. close-out retailer Big Lots' performance will remain stable and we anticipate that the company will maintain its moderate financial policy. -- We are revising the outlook from negative to stable and affirming our 'BBB' corporate credit rating on the company. -- The stable outlook reflects our opinion that Big Lots should continue to perform resiliently in a weak economy, and maintain credit metrics at around current levels. Rating Action On July 11, 2012, Standard & Poor's Ratings Services revised its outlook on U.S. close-out retailer Big Lots Inc. to stable from negative. At the same time, we affirmed our 'BBB' corporate credit rating on the company. Rationale The outlook revision reflects our opinion that Big Lots will perform resiliently and will maintain its moderate financial policy in the future, which should lead to credit metrics remaining close to current levels. Our 'BBB' rating on Big Lots continues to reflect our view of its "satisfactory" business risk profile and "intermediate" financial risk profile. The business risk profile encompasses our opinion that Big Lots will continue to perform resiliently despite a weak economy and high unemployment rates due to the strong value proposition of its product offerings as the leading close-out retailer in the U.S. We expect that profitability will likely improve as management turns around the operations at Liquidation World, the Canadian close-out retailers Big Lots bought in July 2011. But the business risk profile also reflects our anticipation that competition will remain intense in the U.S. value retail segment, with Big Lots' significantly bigger competitors (particularly the discounters) keeping prices low and opening smaller stores in the generally more dense urban areas to attract low- to moderate-income customers. Our forecast for fiscal 2012 (year-end January 2013) and fiscal 2013 include the following assumptions: -- 3%-5% revenue growth. We believe the growth will mostly reflect new store openings as we anticipate flat comparables in fiscal 2012 (taking into account Big Lots' negative 0.8% comparables posted in the first quarter of fiscal 2012) and low- to mid-single-digit comparables thereafter as customers' disposable income remains under pressure and the economy recovers only gradually. -- Limited improvement in profitability. We project an increasing contribution from the company's less discretionary but lower margin Consumables division, and we do not anticipate Liquidation World to be break-even before fiscal 2013. But we believe that administrative and marketing expenses (SG&A) leverage will slightly improve as a percentage of sales as sales increase. -- Capital expenditures similar to fiscal 2011 levels of around $130 million-$135 million, to account for new stores opening of around 50 a year (net store openings). -- Limited share repurchase activity. We anticipate in our base-case scenario that Big Lots will likely largely complete its new $200 million share repurchase program in fiscal 2012, with free cash flow and some borrowings under its revolving credit facility. This is in addition to the $99 million already repurchased in the first quarter. Since we believe the company's annual free cash flow generation capacity is about $200 million, we project that part of the share repurchase activity this year will be debt-financed. We have assumed that share buyback activity will moderate from fiscal 2013 onwards and will be mostly funded by internally generated cash flow, in line with the group's track record of maintaining a moderate financial policy. Under this scenario, we calculate that by the end of fiscal 2012, Big Lots' leverage will not increase materially from the 1.6x we calculate at April 28, 2012, and should remain around 1.5x by the end of fiscal 2013. We continue to characterize the company's financial risk profile as intermediate (which, among other things, typically reflect an adjusted leverage of 2x-3x), reflecting the group's moderate free cash flow capacity of around $200 million a year, and because we believe that Big Lots' short average store lease tenure overstates the strength of its credit measures. After adjusting the company's short average lease tenor to a longer tenure more typical of retailers, we calculate that Big Lots' leverage stood at about 2.7x at April 28, 2012. Liquidity We view Big Lots' liquidity as "adequate," considering its cash and revolving credit facility availability, free cash flow generation, absence of debt maturities, and ample cushion under its financial covenants. Relevant aspects of the company's liquidity profile, based on our criteria and assumptions, are as follows: -- We expect the company's sources of liquidity over the next 12-24 months to exceed uses by more than 1.2x, and believe net sources would be positive, even if EBITDA fell 20%. -- The company currently has no on-balance-sheet debt or debt maturities. -- As at April 28, 2012, there was $643 million available under the group's $700 million revolving credit facility, which matures in July 2016. We believe revolver borrowings could occur during the year due to second-half seasonal inventory growth, and to partially fund the group's share repurchases activity (within the limit of the $200 million program until the end of fiscal 2012). -- We expect cushion under financial covenants to remain above 30%. -- We believe capital expenditures will not materially deviate from the $131 million reported in fiscal 2011, and forecast around $200 million of annual reported free cash flow. -- Big Lots appears to have satisfactory relations with its banks. As of April 28, 2012, the company had close to $83 million of cash on balance sheet. Outlook The outlook is stable. It reflects our view that Big Lots will likely maintain a resilient operating performance and its moderate financial policy over the next 18-24 months, maintaining credit metrics close to current levels, including adjusted debt leverage of around 1.6x. We could lower the ratings if Big Lots' performance was to deteriorate materially from current levels, with sustained negative comparables and a decline in profitability. This could occur if the U.S. economy doesn't improve. In particular, persistently high unemployment would put pressure on customers' disposable income and therefore reduce traffic at Big Lots, whose products are more discretionary in nature than those of discounters that typically offer more essential items. A downgrade of the company could also result from a more aggressive financial policy, which could take the form of Big Lots increasing its share repurchase activity significantly above its free cash flow generation capacity, which we estimate at about $200 million annually. A possible upgrade appears limited at this point because we believe that Big Lots' business risk profile is constrained by the intense competition in the U.S. retail value market, and by the country's macroeconomic outlook, which we project will only improve slowly and gradually over the next two years, Therefore we believe that over the next two years, there is limited potential for a strong improvement in operating performance for Big Lots, which offers fewer consumables than its significantly larger competitors (i.e., discounters). However, we could raise the rating if, absent changes in the company's moderate financial policy, its business risk was to improve, with the company acquiring more scale, improving its profitability in the mid-teens area (from current adjusted EBITDA margins of around 10%), and reducing the volatility of its inventory sourcing. Related Criteria And Research -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Ratings Affirmed; Outlook Action To From Big Lots Inc. Corporate Credit Rating BBB/Stable/-- BBB/Negative/-- Ratings Affirmed Liquidation World Inc. Senior Unsecured BBB Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.