Shares of Bed Bath & Beyond (BBBY), the giant home furnishings outfit, have been in Wall Street’s doghouse for quite a while. In fact, the large-cap stock, a must-own name in retail when the company went public back in 1992, has declined roughly 35% in value over the past year, and is now trading about where it was at the start of the decade. Earnings seem to have flattened out, too, hovering around the $5-a-share mark, as same-store sales have languished (they fell a worse-than-anticipated 1.2% during the August interim) and margins have steadily eroded. (Fiscal years end in late February of the following calendar year.) And the pace of unit development has slowed to a crawl (square footage growth seems apt to approximate 2% going forward), suggesting market saturation and a need to focus on shoring up existing operations. Still, the core Bed Bath & Beyond brand continues to resonate with consumers. And management is taking steps to right the ship, including placing a greater emphasis on proprietary products and pouring a lot of money into the up-and-coming e-commerce business. Will these measures be enough to get the retailer back on a sustainable growth track? And does the issue, as currently valued, make an attractive 3- to 5-year turnaround play? In this brief article, we will attempt to address these questions by taking a closer look at Bed Bath & Beyond’s business and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
The Business
Founded in 1971 by Warren Eisenberg and Leonard Feinstein and based in Union, New Jersey, Bed Bath & Beyond, with over 62,000 employees and a top line in excess of $12 billion, is a leading specialty retailer, focusing predominantly on domestics merchandise and home furnishings. As of August 27, 2016, the company had a total of 1,539 locations, including 1,024 Bed Bath & Beyond stores in all 50 states, the District of Columbia, Puerto Rico, and Canada, 278 stores under the names of World Market, Cost Plus World Market, and Cost Plus, 107 buybuy BABY stores, 79 stores under variations of the Christmas Tree Shops brand, and 51 units under the Harmon and Harmon Face Values banners. Bed Bath & Beyond also operates Of a Kind, an e-commerce site that features limited edition items from emerging fashion and home designers, as well as Linen Holdings, a provider of textile products, amenities, and other goods to institutional customers in the hospitality, cruise line, and healthcare industries. Moreover, it has several stores in Mexico via a joint venture and a burgeoning e-commerce business.
Strengths
Brand Awareness: Bed Bath & Beyond has a huge coast-to-coast presence, established over 45 years, with highly desirable sites in nearly every major metropolitan market. Additionally, though competition from the Web and other distribution channels has begun to weigh on results, the company maintains leading shares in large merchandise categories, such as furniture and specialty home goods. These positions appear fairly entrenched, and should only strength as the company better leverages its brand online, integrates recent acquisitions into the fold, and embraces a more targeted advertising strategy.
Consistent Profitability: Even during difficult times, including the deep recession of 2007-2009, the company has always been highly profitable. We attribute this to the efficiency of Bed Bath & Beyond’s operations (the cost structure is definitely on the lean side), as well as to the disciple of its senior management team, which, led by CEO Steven Temares (since 2003), has done an excellent job of site selection over the years. Plus, the business is levered to broader housing and consumer spending metrics that, while often uneven in the short run, have an upward long-term bias. And customer service has always been a priority, which has historically served the retailer well.
Shareholder Friendly: The company, equipped with excellent free cash flow and a sound balance sheet (the debt-to-capital ratio is around 37%), has been an aggressive purchaser of its own stock over the past several years. In fact, the share base has decreased by approximately 40%, or 100 million, since 2010. And we would expect the buyback activity to persist past fiscal 2016, especially given the deep discount to the broader stock market at which the shares are currently trading. Meanwhile, the company looks to have ample financial flexibility to pursue its growth initiatives and ink accretive “tuck in” acquisitions. And the board of directors has just initiated a quarterly cash dividend of $0.125 a share. This equates to a modest yield of almost 1.3%, though we think that there’s ample room for payout hikes in the years to come.
Weaknesses:
Soft Comp Trends: As indicated, same-store sales slipped a disappointing 1.2% in the fiscal second quarter, despite a higher average ticket and a healthy expansion of the company’s e-commerce business. What’s more, comp trends have decelerated on both a one-year and two-year basis, as in-store traffic has continued to wane against a challenging backdrop for brick-and-mortar retailers. These results are concerning, to be sure, as they point to the heightened competition that Bed Bath & Beyond is facing in multiple distribution channels. And, although year-over-year comparisons are poised to get markedly easier, it may be some time before same-store sales growth returns to the low- to mid-single digits.
Declining Margins: The net profit margin has been shrinking since hitting a near-term plateau of almost 10.5% in 2011. (It will probably drop below 6% this year.) We attribute this to rising pricing pressures, as the company, with the help of generous coupon and free-shipping promotions, has endeavored to keep pace with mass merchants, like Wal-Mart (WMT – Free Wal-Mart Stock Report) and Target (TGT), and online discounters, like Amazon.com (AMZN). Investment spending, largely aimed at broadening the product mix and improving Bed Bath & Beyond’s technology/point-of-sale systems and digital capabilities, has also ramped up, contributing to the profit squeeze. (Capital spending is projected to be between $400 million and $425 million in fiscal 2016.) And increased wages have been a problem, as they have been across the retail landscape.
Opportunities:
E-commerce: Given pressures on store traffic and stiff competition from Amazon, the company has been working hard to generate more online sales. Efforts seem to be paying off, too, with e-commerce growth topping 20% in the August period. We see this momentum persisting well into the future, especially as new digital and mobile investments begin to bear fruit. That said, the e-commerce segment is still a relatively small piece of the pie here, as Bed Bath & Beyond, initially reluctant to think past its cash-cow brick-and-mortar operations, has been quite late to the Internet party. Thus, it may be several quarters before Web and mobile-initiated sales really begin to move the top-line needle. Higher e-commerce volumes may also contribute to the current margin woes, at least at first, since online sales are typically lower margined than in-store transactions.
New Merchandising Initiatives: In an effort to drive “wallet share,” Bed Bath & Beyond, aided by numerous vendor direct to consumer (VDC) programs, has been branching out into new product categories, from vanities and lighting to camping and fitness equipment. In particular, the company has been looking to up its mix of proprietary goods that cannot be found elsewhere. This extension strategy carries some risks, as it threatens to make the company more of an unwieldy jack of all trades. (Critics suggest that the retailer has already become just that.) But new proprietary product assortments, coupled with the rollout of a personalization service that lets customers add their own flair to select items, should enable Bed Bath & Beyond to better stand out in the crowd and regain a measure of its lost market share and pricing power. This will be critical for comps to return to form, in our opinion.
Targeted Advertising: One way to combat the recent traffic malaise, management believes, is with more-targeted marketing efforts. The company’s advertising message may well have gotten too broad, so as to be lost in all the media noise that most consumers confront on a daily basis. Instead, Bed Bath & Beyond will look to customize its sales pitch, recommending not just individual items but entire design schemes that incorporate many products for one’s kitchen or bathroom. This new strategy may explain why the company has invested so much in its technology infrastructure of late, and why it purchased privately held One Kings Lane in June for an undisclosed sum. One Kings Lane is an emerging online furnishing retailer that sells hip, designer merchandise (mostly furniture and home décor) at a deep discount, often using a “flash sale” format that only lasts for a limited time. Its addition should enable Bed Bath & Beyond to better compete with savvy e-tailers and recast itself, at least to some degree, as a design store, rather than merely a mass merchant that competes on price. If forced to play the discounting game, the company will likely continue to see its fortunes dwindle in time.
buybuy BABY: Although overall unit development will likely be moderate, the small buybuy BABY concept ought to be the focal point of the company’s expansion plans over the next several years. Indeed, we think that the chain can grow at an annual rate of close to 10%, thanks to its economical store format (compared with the “big box” Bed Bath & Beyond locations) and to the favorable demographic trends impacting the baby/toddler U.S. retail segment.
Threats
Amazon.com: When it comes to retail, particularly at the higher-cost brick-and-mortar level, the elephant in the room is always Amazon, the ahead-of-the curve online marketplace started in 1994 by Jeff Bezos. Amazon, as with other online home décor specialists like Wayfair (W), sells many of the same commoditized bath and furnishing products that Bed Bath & Beyond does, often at a discount and with free shipping. This overlap has squeezed comp trends and put tremendous pressure on the company’s operating margin in recent years, as we have already indicated. And the stiff competitive headwinds may well persist until Bed Bath & Beyond can develop its own differentiated, proprietary products, and further ramp up its e-commerce business. The company may also be compelled to shutter some of its underperforming units (it’s already doing a bit of this) unless it can do a better job of leveraging its fixed overhead costs. A higher percentage of online sales would probably help in this regard.
Conclusion
In sum, though Bed Bath & Beyond clearly has its work cut out for it, we think that its strengths and opportunities edge out its weaknesses and threats at present. Even better, the valuation is rather attractive, with the stock trading at only about eight times the consensus share-net view (of $4.73) for fiscal 2016. The market should assign the issue a considerably higher P/E multiple, we believe, once same-store sales improve, margins stabilize, and earnings break out of their tight range. This suggests that the equity possesses wide total-return potential through decade’s end, particularly on a risk-adjusted basis and when factoring the likelihood of dividend hikes down the line. We think it’s definitely worthy of consideration for patient investors seeking greater exposure to the retail sector. – Justin Hellman
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
