-- U.S. closeout retailer Big Lots' second-quarter performance was
meaningfully below our expectations.
-- We are removing the ratings on the company from CreditWatch and
lowering them to 'BBB-' from 'BBB'.
-- The negative outlook reflects our view that Big Lots' future profits
may remain below historical levels partly because of its cash-strapped
On Nov. 9, 2012, Standard & Poor's Ratings Services removed all of its ratings
on Columbus, Ohio-based Big Lots Inc. from CreditWatch, where they were placed
with negative implications on Aug. 23, 2012, and lowered the ratings to 'BBB-'
from 'BBB'. The outlook is negative.
As of July 28, 2012, Big Lots had about $243 million of debt outstanding.
The downgrade reflects our expectation that operating weakness will continue
as Big Lots' core customer base remains cash strapped and the company
continues to modify its merchandise offering following an unenthusiastic
consumer response to its discretionary offerings. We forecast that for the
remainder of fiscal 2012, sales and profit pressure will continue as consumers
modify their purchasing behavior, including overall reduced spending on
higher-cost discretionary items and a shift toward lower-margin consumables.
In our opinion, Big Lots' planned testing of coolers and freezers and of full
market remodels may be indicative of some weakness in its underlying business
model. Big Lots' performance for the quarter ended July 28, 2012, included a
30% drop in core U.S. store operating profit and commensurate credit measure
The ratings on Big Lots reflect our opinion that the company has a
"satisfactory" business risk profile with a competitively priced product
offering, partly due to the generally lower cost nature inherent to closeout
retailing, and what we still consider to be a good management team. Key risk
factors include substantial competition from large mass-merchant discounters
and a customer base that includes less affluent, moderate income consumers who
are more susceptible to inflationary pressures and persistently high
view Big Lots' financial risk profile as "intermediate", mainly reflecting its
moderate financial policy as demonstrated by limited use of on balance sheet
debt and satisfactory free cash flow generation. The continuation of its
moderate financial policy is a key rating factor.
The company is testing the introduction of coolers and freezers in some of its
stores. We believe the intent is to evaluate whether a more complete product
offering-including food items-will result in incremental purchases of higher
margin discretionary items by driving store traffic, including winning
business with Supplemental Nutritional Assistance Program (SNAP) customers. It
is not clear to us that offering low margin food items will necessarily drive
significant purchases of higher margin discretionary items, especially by SNAP
customers. We are also skeptical Big Lots could effectively compete on price
for food items against large grocers and mass merchants.
Big Lots is also testing a full market remodel plan, which is intended to
provide a "like-new" in-store experience. We think a rollout of this plan to a
meaningful number of its stores would require a large capital investment.
Our forecast for fiscal 2012 (year-end January 2013) and fiscal 2013 include
the following assumptions:
-- We forecast modestly lower comparable store sales as core customer
disposable income remains under pressure and the economy remains weak.
-- EBITDA declines by 10%-15% in 2012, followed by a low single digit
decline the following year as lower margin consumables account for an
increased proportion of Big Lots' sales. Although its performance is
improving, we do not anticipate its Canadian subsidiary to break even before
-- Annual capital expenditures fall to about $115 million, reflecting the
potential for a pared back store expansion program.
-- Our forecast does not assume a large scale rollout of Big Lots'
planned cooler and freezer or full market remodel tests, the latter of which
could add considerably to capital expenditures.
-- Share repurchases of around $300 million for fiscal 2012 and $200
million annually thereafter.
Under this scenario, we forecast debt leverage at 2.25x-2.5x over the next 18
months, about 50% funds from operations (FFO) to total debt, and 6.5x EBITDA
interest coverage. These credit ratios are only slightly weaker than levels
reported for the 12 months ended July 28, 2012. However, we believe Big Lots'
short average store lease tenor makes our adjusted credit ratios appear
stronger than they would be if longer lease tenors were used. If we adjust its
lease tenor to levels more typical of most retailers, leverage increases to
about 3.3x, FFO to total debt declines to 40%, and EBITDA interest coverage
falls to about 4x. In our opinion, these ratios are more indicative of Big
Lots' credit health.
We view Big Lots' liquidity as "adequate" considering its existing liquidity
sources, absence of meaningful debt maturities, and ample financial covenant
cushion. 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 15%.
-- As of July 28, 2012, Big Lots had $62 million cash and $383 million
availability under its $700 million revolving credit facility (net of $243
million borrowings and about $74 million letters of credit) due July 2016.
Seasonal revolver borrowing particularly in the third quarter occurs to
support holiday inventory growth.
-- We expect cushion under financial covenants to remain above 30%.
-- We forecast capital expenditures to decline to around $115 million. It
is possible capital expenditures could increase starting in 2014 depending on
whether Big Lots' rolls out its tests.
-- We forecast around $200 million of annual free cash flow generation.
-- Big Lots appears to have satisfactory relations with its banks.
The outlook is negative. We expect demand for Big Lots' merchandise to remain
weak if spending by its customers, which we believe includes less affluent,
moderate income households, declines because of general inflation pressure,
potentially reduced transfer payments from governments, and continued high
unemployment. It is also possible Big Lots could be more aggressive than we
assume with respect to financial policy, particularly share repurchases.
We could lower the ratings if financial policy becomes more aggressive than we
currently expect or if profitability declines further, resulting in leverage
exceeding 3.5x using a rent multiple that is more typical of retailers. We
think this could occur if EBITDA falls by about a high single digit rate. An
outlook revision to stable could occur if we believe Big Lots will maintain an
overall moderate financial policy and if profitability stabilizes and begins
to improve, leading to leverage (adjusted to a more typical rent multiple)
under 3x, which we think can occur if EBITDA improves by around 10%.
Related Criteria And Research
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- Use of CreditWatch and Outlooks, Sept. 14, 2009
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Corporate Ratings Criteria 2008, published April 15, 2008
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
Downgraded; CreditWatch/Outlook Action
Big Lots Inc.
Corporate Credit Rating BBB-/Negative/-- BBB/Watch Neg/--
Big Lots Stores Inc.
Senior Unsecured BBB- BBB/Watch Neg