I'm sure there is nothing more frustrating than to read an article on a company with a great management team and superb execution during the toughest operating environment for housing since the Great Depression of the 1930s, and then see "fully valued" in the headline of the article. Unfortunately, that is my take on Bed Bath & Beyond here (BBBY), which operated superbly during the housing depression from 2007 through early 2012, with the stock returning 89% from its close in 2006 near $38.12 to its high in mid-2012 of $72. Those were tough times for anything housing-related, yet BBBY stood out like a green (as in money) thumb thanks to excellent management and superb retail merchandising.
However, even though housing on a national basis has really begun to recover smartly, BBBY has been an underperformer the last year. It's up around 10% for the last 12 months (starting July 1, 2012) vs. a 20% return for the SP 500. It was almost exactly a year ago (mid-June 2012) when the stock traded up to $72 per share and then disappointed with its Q1 2013 earnings report, sending the shares tumbling from $75 to $60 -- remarkably just as the housing recovery was gathering steam.
When BBBY reports its fiscal Q1 2014 quarter after the close on Wednesday, June 26, 2013, analyst consensus is expecting $0.93 in earnings per share (EPS) on $2.6 billion in revenue, for estimated year-over-year growth of 4% and 17%, respectively. The one estimate we've seen for BBBY's quarterly comp is 3%, up from a 2.5% actual comp last quarter.
For Q1 2014, EPS estimates have been fairly stable since the last earnings report, while the consensus revenue estimate has ticked slightly higher. Last quarter, which was Q4 2013 reported late March, saw revenues increase 24%. EPS rose 14%, on 2.5% comps, the first sequential increase in comps since early 2012.
The Big Issue at BBBY
Gross margin has been compressing, based on couponing and possible loss of sales to the Internet (channel issues). That is the first major problem, as the following table shows:
|1/13||41%||-1.58%||17.6%||-258 bp||11.0%||-186 bp's|
|1/11 q4||43%||0.39 bp's||18.4%||188 bp's||11.3%||124 bp|
Source: Internal spreadsheet.
BBBY has been seeing margin compression for the basically the last four to five quarters, with the key question being: Has the compression ended, or is the fact that BBBY laps easier comps from 2012 now making the stock a compelling buy? Given the above table, the margin estimates for the April quarter are pretty conservative and seem to be screwed down pretty tightly. The bullishness around the stock stems from BBBY's correlation with housing, which has had a remarkable rebound over the last 12 months, and an improved website and Internet marketing campaign, which has allowed BBBY to stem the Amazon erosion.
BBBY is trading at 14x the current fiscal 2014 estimate of $5.02 and 12x the fiscal 2015 estimate of $5.62 for expected year-over-year EPS growth this year and next of 3% and 12%, respectively. It seems as if analysts' current consensus estimate of $5.02 for fiscal 2014 (ending January 2014) still incorporates worries over margins and issues around incorporation of the CostPlus acquisition. Management's guidance for fiscal 2014 will be critical.
The other issue around valuation is the 12x cash-flow price at the current trading level and the 6% free-cash-flow yield. Also, BBBY is basically using all of its excess cash flow at this point to repurchase stock, which isn't a bad thing. But after peaking at $1.2 billion about two years ago, BBBY's balance sheet cash has been cut in half, so management is pushing the share repo to the limit. So 12x cash flow is not that attractive a valuation for us.
Finally, our internal model values BBBY at $70 per share, exactly where Morningstar puts its "fair value" estimate of BBBY. That is somewhat unusual since, if you look at all of our earnings previews on Seeking Alpha, our internal valuation model almost always seems to value our companies at a premium to Morningstar's valuation. The point being, with the stock trading at $69 and the intrinsic value estimate at $70, we see more risk than reward at current prices.
Most think that with the housing recovery in full-steam-ahead mode, BBBY will get another tailwind and take off again. It could, but investors get much better earnings growth buying homebuilders or banks these days than buying housing exposure through BBBY, as it works through the margin compression and swallowing CostPlus.
We are going to give it more time. A trade above $73 on volume and the stock breaks out again, so we give up a possible 5% on the upside to wait and see what happens (see chart below). It is a very good management team that really earned their stripes between 2006 and 2012. However, there is better risk/reward in the housing sector until BBBY shows it has worked through the operating issues.
Click to enlarge image.