Opacity Doesn't Help The Cause At Bed Bath & Beyond

By Stephen D. Simpson, CFA | September 20, 2012 AAA

Investors always seem to want more information from companies, and there's certainly a point of diminishing returns for companies when it comes to their level of disclosure. Nevertheless, I think Bed Bath & Beyond (Nasdaq:BBBY) is doing its shareholders a disservice by not breaking out its costs and charges in more detail in its earnings press release. As it stands, I don't think Bed Bath & Beyond is an especially compelling retailer at today's prices.

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Middling Second Quarter Performance
Bed Bath & Beyond did okay in its fiscal second quarter, but really didn't do much to address longer-term concerns about growth, competition or margins. Revenue rose 12% this quarter, with comp growth of about 3.5% and nearly 7% growth from acquisitions. That comp number was a little light of sell-side expectations (which had been creeping up to 4%) and does show deceleration on both one-year and two-year comparisons. Unfortunately, management did not offer up much information on the performance of Cost Plus during the quarter.

Likewise, the company's profit performance was a little disappointing and a little murky. Gross margin declined more than a point due to high ongoing levels of couponing and the inclusion of Cost Plus (a business with lower margins). Operating income declined about 2%, as reported, leading to a two-point decline in operating margin. While some of this underperformance was due to acquisition charges and the lower margins of Cost Plus, the lack of detail from management makes any attempt to 'suss out' the core profitability of the business into a guessing game.

SEE: A Look At Corporate Profit Margins

Are Competitors Taking a Bigger Bite?
The home goods/housewares industry has been pretty strong this year, but I'm not sure Bed Bath & Beyond is at the head of the list anymore. With Green Mountain Coffee Roasters' (Nasdaq:GMCR) Keurig making up a significant portion of the company's sales in recent times, a slowdown here could be explaining some of the flagging momentum in same store sales. At the same time, though, I wouldn't rule out the improvements at competitors like Pier 1 (NYSE:PIR) and Williams Sonoma (NYSE:WSM) as playing a role. This could be particularly relevant if the new Starbucks (Nasdaq:SBUX) Verisimo machine (which will initially be available at Bed Bath & Beyond rivals Williams Sonoma, Macy's (NYSE:M) and Sur La Table) really catches on with customers.

I also think that Bed Bath & Beyond may be seeing a little more competition at the lower end of the price scale from the suite of companies operated by TJX (NYSE:TJX). I don't know, though, that Amazon (Nasdaq:AMZN) is a huge factor yet - Bed Bath & Beyond's demographics have usually skewed older than Amazon's core market and active couponing mitigates a lot of Amazon's price advantage.

The Bottom Line
Assuming that the U.S. can support about 1,300 Bed Bath & Beyond stores, the company is about three-quarters of the way through its store-building. Once that process slows, free cash flow should improve, though there will be ongoing refurbishment needs. Of course, the company may choose to start/buy additional store concepts (such as Cost Plus/World Market) and support those with additional store units, to say nothing of supporting existing concepts such as buybuyBaby.

It's also worth noting that the company seems to be exploring the idea of adding more food offerings to the Bed Bath & Beyond stores - a change in merchandising that could improve traffic, but at the cost of margins (food offers lower margins).

Worries about competition may create some headwinds for the stock in the short term - headwinds that aren't helped by the company's relative lack of disclosure/transparency. In any event, I do believe that the company will continue to grow its cash flow, just not at a high enough rate to make the stock interesting here. Mid-to-high single-digit free cash flow growth would support a price target in the mid-$70s to high $80s today, but today I'm currently looking for sub-5% growth and the stock looks like more of a hold as a result.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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