Is my investment principle safe? This is the number one question that runs through my mind before I make any investment. This leads me to be extremely contrarian, I love going against the grain and observing why investors behave the way they do, often by playing devils advocate.
This contrarian thought process led me to Big 5. There was something special about Big 5. I believe it is undervalued sure, but it also has an extremely large short interest. I thought this might be an interesting opportunity to try my hand at something a little unique and play the short squeeze.
What Makes Big 5 a Short Squeeze Candidate?
The short interest currently sits at around 47%. The days to cover according to Nasdaq.com was at a little above 15 days at the end of April. Most short squeeze professionals look for anything in the double digits for potential candidates.
The days to cover is achieved by taking the average daily volume and dividing that by the shares that are short. This gives an idea of how many days it would take for the shorts to completely buy back shares. The higher the days to cover gets the greater the potential shorted shares will encounter massive price surges in a single day.
In order for the price surge to take place there needs to be a catalyst. There have been a few items building up that may lead to a trigger of this short squeeze.
Big 5 has been buying back shares below book value providing extra value to investors. Big 5 has continued paying a dividend.
Director Van B Honeycutt has begun purchasing shares. Big 5 had a better than expected Q1
These are great and all but, what will finally cause the squeeze?
The inventory has increased after the results of the Q1. Its important to note that Big 5 purchases its inventory ahead of season. This means that not only did it not have good Winter sales because of weather, but it also had Spring inventory on hand.
This could lead to a potential 2nd quarter windfall since it has both Spring and Winter inventory. Big 5 reported a sales increase of Winter related product In March and moving into Q2 that accounted for its surprise earnings. If this trend continues into the first part of Q2 and we see an uptick in Spring merchandise sales there is potential for a massive beat.
If you are a little skeptical about whether my theory has ground, just take a look at these comments from Steve Miller.
Turning now to the second quarter. As mentioned our positive sales and margin trending has continued through April. Same-store sales for the quarter to-date are up in the low single-digit range which includes the benefit of the Easter calendar shift. (Source)
It is apparent already that a massive beat is in the cards for Q2 of 2018 with the positive sales trends from March moving into April. Barry Emerson also had more to say about the winter product mix moving into Q2.
Turning to the balance sheet, our chain wide merchandise inventory at the end of the first quarter was up 6.3% on a per store basis versus the prior year reflecting an increase in winter related products after our unseasonably warm and dry winter. We are comfortable reintroducing this winter product carryover next season and we see a little markdown risk associated with it. (Source)
This should keep margins high for Winter product into the Spring season as there is little risk for markdown for the following Winter season. If there are any Winter clothing sales moving into Q2 because of unusually cold weather, it should be especially true that there is little risk of clearing inventory with discounts.
If you still don’t believe these will be enough to produce a surprise beat in Q2 take a look at Steve Millers comments on last years Summer.
As a reminder last year, we had a slow start to the summer with heavy snow pack and unusually high water levels in our rivers and lakes, closing campgrounds and impacting participation in summer recreation activity throughout much of California. (Source)
The snow pack is not as high as last year. In fact it is below average. This might help out sales in late June for Summer related product. This could in theory bring a trifecta of seasonal sales contributing to a massive beat.
Management’s Guidance for Q2
We would not be able to trigger an earnings beat without first looking at the Guidance. Below Mr. Emerson discusses Q2 guidance.
For the fiscal 2018 second quarter, we expect same-store sales to be in the flat to positive low single-digit range and earnings per diluted share to be in the range of $0.04 to $0.12. Second quarter guidance reflects a small benefit as a result of the calendar shift of the Easter holiday, which is expected to be offset by a small negative impact from the July 4 holiday, shifting 1 day further into our third quarter this year. For comparative purposes, in the second quarter of fiscal 2017, same-store sales increased 0.8% and earnings per diluted share were $0.13.” (Source)
In Q2 Big 5 is predicting positive earnings. This is much different from the Q1 Guidance which was negative. It is important to produce profits in Q2 in order to keep up with cash flow strains. Since the guidance is in the single digits any surprise in the double digits for Q2 will essentially trigger the short squeeze.
Mr. Emerson does not take into account anything affecting the guidance other than the two holidays. If two of the situations I explained above (Winter, Spring, and Summer sales trifecta) play out then this should push earnings into the double digit range.
The Short Interest Decreased Moving into Q2
The Short Interest for Big 5 according to Nasdaq has been steadily decreasing from the high in February. This implies that shorting the stock no longer looks attractive. This could be attributed to the better than expected earnings for Q1 and the positive guidance for Q2.
The average daily volume remains low and the stock is gaining support in the 7 dollar range. The days to cover should remain above 10 days. This is especially true since the number of shares outstanding has decreased from buybacks.
I would recommend Big 5 as Buy unless it appreciates significantly before a positive earnings quarter. This way you can safely purchase below current book value with potential for a short squeeze.
Disclosure: I am/we are long BGFV.
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.