Q1 Results Highlight The Risks At Bed Bath & Beyond

By Stephen D. Simpson, CFA | June 17, 2012 AAA

Occasionally, companies report earnings that really can be read and interpreted in opposite, but equally valid, ways. That seems to be the case with housewares superstore operator Bed Bath & Beyond (Nasdaq:BBBY). Pessimists can point to weak comp growth despite promotions as proof of weakening fundamentals, while optimists can argue that this quarter's weakness was as expected and the company's recent acquisitions show a prudent aggression towards building the business.

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Weak Q1 Results Drive the Worry
There was not all that much good news in the financial results reported by Bed Bath & Beyond. Revenue rose just over 5%, with comp growth of only 3%. That's a big drop for the 7% comp last year, and the company saw pressure from shifts away from merchandise like Green Mountain Coffee Roasters' (Nasdaq:GMCR) Keurig machines and supplies.

SEE: Earnings Quality: Introduction

Making matters worse, the company was more aggressive with couponing this quarter and that, coupled with shifts to lower-margin products, led to a greater than half-point drop in gross margin. Unfortunately, this was the worst of both worlds - BBBY took the hit to margins without improved same store sales.

Where BBBY did do well, though, was in controlling its operating expenses. This isn't a new development for this well-run retailer, but it did help boost operating income growth above 8%.

Acquisitions and New Brands Expanding Opportunities
One of the bear stories on Bed Bath & Beyond is that there's not much further that the company can go with its housewares superstore format. Most of the places that need, or want, a BBBY store already have one, and companies like Williams Sonoma (NYSE:WSM), Crate & Barrel, IKEA, Walmart (NYSE:WMT) can chip away at them. That's probably not entirely true, but the point is that the company is not likely to see a lot of growth from building more Bed Bath & Beyond stores.

SEE: The 4 R's Of Investing In Retail

Now the company is getting more aggressive. The company has three new brand concepts still in relatively early stages of development - Christmas Tree Shops, buybuyBaby and Harmon Face Values. These stores were brought in via acquisitions and have worked out relatively well so far.

Based on good initial results, the company is going back to that well in a big way. The company is spending close to a half a billion dollars to buy Cost Plus Market (Nasdaq:CPWM) and another $100 million for Linen Holdings. Cost Plus has already gone a long way towards turning itself around, and BBBY should be able to boost profitability and the store count. Linen Holdings is arguably the more risky deal - putting the company in more of a business-to-business distribution business where it has less experience.

The Bottom Line
I can appreciate why bears are negative on this name - I don't see the obvious opportunity for robust comp growth in the core store concept, and the stock has been pretty highly valued for a while now. That said, the company has done pretty well with acquired properties in the past and I can see how management can transform Cost Plus's World Market stores into more formidable competition to Williams & Sonoma and Pier 1 (NYSE:PIR). Likewise, I think there is good store expansion potential for buybuyBaby and Harmon.

SEE: Analyzing An Acquisition Announcement

All of that said, Bed Bath & Beyond is not startlingly cheap, even with the big negative reaction to Q1 earnings. If the company can grow its cash flow at a high single-digit clip over the next decade, these shares may be interesting, but that's a pretty aggressive assumption, even with the growth potential of these acquired stores.

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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