Bed Bath & Beyond: An Undervalued Play On Economic Growth

Feb.17.14 | About: Bed Bath (BBBY)

January was a disappointing month for shareholders of Bed Bath & Beyond's (NASDAQ:BBBY). The share price fell from ~$80.00 to a low of ~$62.00 representing a decline of 22.5%. Some of the reasons for this drop in price include: slower-than-expected growth which caused the company to "miss" by more than a dime, as well same store sales were much lower than anticipated. These factors led to the company lowering guidance which added to shareholder concerns. So as the stock dropped by over 20% in January the question is, is it time to pick up shares in Bed Bath and Beyond or is it time to say bye?

Bed Bath & Beyond Inc., and its subsidiaries operates a chain of retail stores, operating under the names Bed Bath & Beyond, Christmas Tree Shops, Harmon and Harmon Face Values, buybuy BABY & World Market or Cost Plus World Market.

Since 2009 the company's share price has been on a strong uptrend. In this period the price has increased by ~300%. In the section below, I will analyze aspects of Bed Bath and Beyond's past fundamental performance to show why the stock has had such a strong run. From this evaluation, we will be able to see how BBBY has fared over the past five years regarding their profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals that could give us some insight as to what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2011 = $791 million
  • Net income 2012 = $990 million
  • Net income 2013 = $1.038 billion
  • Net income 2014 TTM = $1.063 billion

BBBY Net Income (<a href=

BBBY Net Income (TTM) data by YCharts

Over the past four years Bed Bath and Beyond's net profits have increased from $791 million in 2011, to $1.063 million in 2014 TTM. This represents a 34.39% increase.

  • Operating income 2011 = $1.288 billion
  • Operating income 2012 = $1.568 billion
  • Operating income 2013 = $1.638 billion
  • Operating income 2014 TTM = $1.686 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years BBBY's operating income has increased from $1.288 billion to $1.686 billion in 2014 TTM. This represents an increase of 30.90%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.

  • Net income growth

    • Net income 2011 = $791 million
    • Net income 2012 = $990 million
    • Net income 2013 = $1.038 billion
    • Net income 2014 TTM = $1.063 billion
  • Total asset growth

    • Total assets 2011 = $5.646 billion
    • Total assets 2012 = $5.725 billion
    • Total assets 2013 = $6.280 billion
    • Total assets 2014 TTM = $6.544 billion
  • ROA - Return on assets

    • Return on assets 2011 = 14.00%
    • Return on assets 2012 = 11.99%
    • Return on assets 2013 = 16.52%
    • Return on assets 2014 TTM = 16.24%

Over the past four years BBBY's ROA has increased from 14.00% in 2010 to 16.24% in 2014 TTM. This indicates that the company is generating more income off its assets than it did in 2010.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2011 = $5.646 billion
    • Total assets 2012 = $5.725 billion
    • Total assets 2013 = $6.280 billion
    • Total assets 2014 TTM = $6.544 billion
    • Equals an increase of $898 million
  • Total liabilities

    • Total liabilities 2011 = $1.715 billion
    • Total liabilities 2012 = $1.802 billion
    • Total liabilities 2013 = $2.200 billion
    • Total liabilities 2014 TTM = $2.415 billion
    • Equals an increase of $700 million

Over the past four years, BBBY's total assets have increased by $898 million, while the total liabilities have increased by $700 million. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2011 = $4.074 billion
    • Current assets 2012 = $4.143 billion
    • Current assets 2013 = $3.867 billion
    • Current assets 2014 TTM = $4.055 billion
  • Current liabilities

    • Current liabilities 2011 = $1.322 billion
    • Current liabilities 2012 = $1.339 billion
    • Current liabilities 2013 = $1.635 billion
    • Current liabilities 2014 TTM = $1.833 billion
  • Current ratio 2011 = 3.08
  • Current ratio 2012 = 3.09
  • Current ratio 2013 = 2.37
  • Current ratio 2014 TTM = 2.21

Over the past four years, BBBY's current ratio has decreased. As the current ratio is well above 1, this indicates that Bed Bath and Beyond would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2011 shares outstanding = 258 million
  • 2012 shares outstanding = 244 million
  • 2013 shares outstanding = 228 million
  • 2014 TTM shares outstanding = 212 million

BBBY Shares Outstanding Chart

BBBY Shares Outstanding data by YCharts

Over the past three and a half years, the number of company shares has decreased from 258 million to 212 million.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2011 = $3.623 billion / $8.759 billion = 41.43%
  • Gross margin 2012 = $3.931 billion / $9.500 billion = 41.37%
  • Gross margin 2013 = $4.389 billion / $10.915 billion = 40.21%
  • Gross margin 2014 TTM = $4.663 billion / $11.702 billion = 39.85%

Over the past four years, Bed Bath and Beyond's gross margin has dropped slightly. The ratio has decreased from 41.43% in 2011 to 39.85% in 2014 TTM.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $8.759 billion
    • Revenue 2011 = $9.500 billion
    • Revenue 2012 = $10.915 billion
    • Revenue 2013 = $11.702 billion
    • Equals an increase of 33.60%
  • Total Asset growth

    • Total assets 2011 = $5.646 billion
    • Total assets 2012 = $5.725 billion
    • Total assets 2013 = $6.280 billion
    • Total assets 2014 TTM = $6.544 billion
    • Equals an increase of 15.91%

Over the past four years the revenue growth has increased by 63.59% while the assets have increased by 59.71%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Bed Bath and Beyond has produced very strong results from a fundamental point of view. Even though the company reported weaker than anticipated results this past quarter, long-term the trends still remain bullish. Revenue over the past four years have increased by 33.60% outpacing the asset growth indicating an increase in shareholder value. The company shares have declining and the ROA has been increasing indicating they are making more money on their assets than they did four years ago. On the negative side BBBY's gross margin has decreased from 41.43% in 2011 to the current gross margin of 39.85%. Based on the analysis above we can see that BBBY has shown significant growth fundamentally which has been reflected in the share price.

Valuations

EV/EBITDA = Enterprise Value/Earnings Before Interest, Taxes, Depreciation and Amortization

In the next section, I will use the EBITDA to calculate the EV/EBITDA. The adjusted EBITDA takes into account foreign exchange and share-based payment expenses. The EV/EBITDA ratio is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm. Retail (Special lines) stocks typically have an EV/EBITDA ratio that trades in the 10.0x to 12.0x trading range.

Enterprise Value or EV = Market Capitalization + Total Debt - Cash and Cash Equivalents.

  • EV - $13.987 + $0 million - $471 million = $14.458 billion
  • EV = $14.458 billion
  • EBITDA = $1.902
  • EV/EBITDA = 7.60

As the Retail (Special lines) sector often trades in the 11.94 trading range, an EV/EBITDA ratio of 7.60 indicates at current levels the stock is trading just fair value compared to other companies in its sector.

Other metrics that indicate the stock is undervalued are: Bed Bath and Beyond has a P/B of 1.22, which is inline with the industry average of 1.17, a P/S of 3.4, which is below the industry average of 5.14 and a P/FCF of 12.05, which is above the industry average of 16.42.

The preceding valuation metrics are indicating that BBBY may have sold-off too aggressively over the past month or so. As we have determined that the company is undervalued what is the current value of the company right now?

DCF Valuation

I believe using the Discounted Cash Flow valuation model for Bed Bath and Beyond to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

FY 2011 FY 2012 2013 TTM
Operating Income 1,568 1,638 1,686
Taxes 580 580 622
Unlevered Net income 988 1,058 1,064
D&A 184 195 216
EBITDA 1,752 1,833 1,902
Free Cash Flow 982 838 882
WACC 6.73%
Terminal Value 11.94X EBITDA 22,710
Total Cash Flow 982 838 25,412
Net Present Value $22,557.22
Total Debt 0
Cash and Cash Equivalents $471.00
Net Debt -$471.00
Equity Value $23,028.22
Shares Outstanding 212
Current Value $108.62
Click to enlarge

Even though there are variations in calculating this formula, this model is based off of a terminal value of $22.710B and a WACC of 6.73%. The terminal value $22.710B is based off of the company trading at 11.94X EBITDA which is the Retail (Special lines) average EBITDA. Using the DCF method to find the value of the company indicates the company shares are very undervalued.

Catalysts

As the company is significantly undervalued what are the drivers moving the stock forward?

As the economy slowly improves and discretionary spending increases, this will benefit the retail industry. To add to the benefits of the improving economy an increase in the housing market will also give people confidence to spend money on their homes. Bed Bath and Beyond is one company that will greatly benefit from this trend.

With a strong network of more than 1,100 stores in the U.S., coupled with a strategic plan to align merchandise according to regional climate and demographics, this will give BBBY a competitive edge within its position in the market.

The Company's objective is to be the customer's first choice for products and services in the categories offered. As this strategy is to achieve this objective through excellent customer service, an extensive breadth and depth of assortment, everyday low prices and introduction of new merchandise offerings this will continue to drive growth.

Forward P/E to create a target

As the company looks to grow with the economy and take advantage of the situation despite recent set-backs future earnings look strong. The Nasdaq has FY 2017 high earnings projected at $6.30. Combine that with a forward P/E of 12.32 this leads to a target price of 2014 price target of $77.49.

As of February 16th, BBBY was trading at $65.69. Using the forward P/E model, this indicates that the stock has a 17.96% potential upside from this point.

Conclusion

Much like economy, Bed Bath and Beyond's growth is going to have "bumps on the road". As the share price declined significantly over the past month, I believe this has presented a significant opportunity for investors. To support this statement my wife added BBBY to her account last week. As the company's strategic plan is to capitalize regionally and housing market looks to be gaining strength this should provide growth for the company moving forward.

Based on the analysis above, company fundamentals remain bullish, the stock is undervalued and even though there was a temporary set-back in the short-term, growth seems to be on track. Based on the forward P/E model, I have a 2014 target of $77.49.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.