The market discounted Bed Bath & Beyond Inc. (BBBY) for the third consecutive quarter post the announcement of the financial results, in light of the company's providing both fourth quarter and full year guidance that fell short of consensus estimates. It would appear, however, that a case could be made that the market has taken a punitive view toward BBBY (see this article by Baron's, for some short sighted reporting), considering the business appears to be in the midst of transition and does not appear to be in a secular decline. Let's consider the following:
- The company reported a weak 1.7% SSS for the quarter-ended 11/24/12, down relative to the 4.10% reported in the third quarter of 2011 and below the 2.0%-4.0% guidance provided by management during the previous quarter. However, the company noted that Hurricane Sandy led to an estimated decline of 0.9% to SSS, which would have put SSS in the middle of the guidance range. Further, the estimate of 0.9% is nothing more than a guess: absent Sandy, which led to store closings and, as management noted on the call, shifts in spending habits, the SSS could have proven stronger. Irrespective, the SSS numbers were impacted by what is reasonable to consider an extraordinary item.
- Even in light of soft SSS number, Gross Profit was up 12.0% year-over-year and Operating Profit was up 1.3%, a nice reversal from the -1.7% decline in the second quarter. Granted, some of the top-line was driven by the acquisitions of Cost Plus, Inc. (closed on June 29, 2012) and Linen Holdings, LLC (closed on June 1, 2012), but the expense items (that impact Operating Profit) are also skewed a bit to reflect the cost of the acquisitions as well. Irrespective of the mix (as SSS distorted the numbers down while the acquisitions distorted the numbers up), the overall BBBY continues to grow and remains a bit tough to model considering the company isn't the most forthcoming on disclosure (explaining somewhat the consensus being off).
- Speaking of growth, the company continues to invest in growing the buybuy Baby stores, an brining up stores to 78 from the year-end 64 (Bed Bath & Beyond stores are up too, to 1,003 from 993 at year-end, but clearly the highest growth rate in square footage is at buybuy Baby). Despite some of the headwinds that will be picked up by the mainstream research analysts (who will focus on gross margin holding down a bit on coupons being used to drive revenue, which is a bit silly, as the U.S. is operating in a tough economy on the Middle Class U.S. consumer, so a company sacrificing 1.0%-2.0% of gross profit to drive topline seems smart, at least to me, but I digress), a real story developing here is the continued expansion of the buybuy Baby franchise. The store count has almost doubled in two years, and the business is completely different than the Bed Bath & Beyond offering (providing an outstanding opportunity for diversified growth in cash flow and earnings over the long-term, assuming the growth trajectory in the store count continues at a reasonable pace). Further, Cost Plus, Inc. (through the World Markets brands) added 264 stores to the overall BBBY franchise, adding more growth and diversifying away from the core Bed Bath & Beyond stores.
- Even while growing stores, BBBY has a pristine balance sheet, with no debt, cash and equivalents of $672.3 mm and short-term investments of $112.5 mm. The company has grown, reduced shareholder capital (and is going to continue to do so) and has maintained complete financial flexibility in the process, through taking on no leverage. Not that a little bit of debt to fund more share repurchases would be a bad thing per se, but we can't have everything.
- The company announced a new, $2.5 billion share repurchase authorization (against a market capitalization of $13.8 billion), to be completed over the next three years and when the existing $223 billion repurchase program is finished. Since the FY 2004, the company has retired 26.1% of the outstanding shares of the company. In under 10-years (and during a substantive recession, it is worth noting), BBBY has continued to grow the business (through adding stores and acquisitions), while at the same time borrowed nothing and retired a bit over 25% of the company. The track record of the senior management (led by the founders) should be considered when thinking about a long-term investment in a company, and BBBY's management has done an exceptional job.
The bottom line here is that BBBY management appears to be transitioning the company for growth through diversity (buybuy Baby, World Market), has kept the balance sheet in exceptional shape while reducing the public float in a substantive way and is finding ways to grow in what should be considered a reasonably challenging period for the consumer. Trading at around 12.2x 2013 estimates, BBBY is being discounted to a historically low valuation.
BBBY certainly is not a go-go growth story, and some patience might be required. But considering the aforementioned, maybe it is worth getting between the sheets with BBBY considering what has been priced in.