Bed Bath & Beyond Outlook Examined By Capital Ladder Advisory Group

Aug.12.14 | About: Bed Bath (BBBY)


Gross Profit margins dip below 39 percent during Q1 2014.

Bed Bath & Beyond takeover or buyout is unlikely.

Omni-channel competition is just as relevant as brick-and-mortar competition.

As of the most recently reported quarterly results, Bed Bath & Beyond (NASDAQ:BBBY) operates 1,504 stores in North America and Mexico. Of these 1,504 stores, they consist of 1,016 Bed Bath & Beyond stores in all 50 states, the District of Columbia, Puerto Rico, and Canada; 268 stores under the names World Market, Cost Plus World Market, or Cost Plus; 92 buybuy BABY stores; 78 stores under the names Christmas Tree Shops, Christmas Tree Shops andThat!, or andThat!; and 50 stores under the names Harmon or Harmon Face Values. What has made Bed Bath & Beyond so successful over the last 25 years has been its unique store format combined with its merchant driven merchandising standards and strategies. While these variables had once been a feather in the company's hat, they are now becoming ruffled under the pressure of increased e-commerce competition and a consumer environment, which is ever-increasingly levered toward discounting goods. Bed Bath & Beyond continues to increase its e-commerce presence, but this may not be the actionable advance the company will more broadly benefit from as pretty much every retailer of scale has and continues to commit to the exact same thing. Target (NYSE:TGT), Kohl's (NYSE:KSS), Macy's (NYSE:M) Wal-Mart (NYSE:WMT) and J.C. Penney (NYSE:JCP) have all directed capital expenditures designated to enhance their respective e-commerce channels. Therefore, the competitive landscape for brick-and-mortar retailers will only be extended in similar fashion to e-commerce and omni-channel venues.

With Bed Bath & Beyond recently reporting Q1 2014 results that disappointed investors, let's take a look at those results.

  1. Net earnings per diluted share of $0.93.
  2. Net sales for the fiscal first quarter were approximately $2.7 billion, approximately 1.7% higher than in the prior year. Of this increase, approximately 24% was attributable to the increase in comp sales and approximately 76% was primarily from new stores and Linen Holdings.
  3. First quarter comp sales increased by approximately 0.4% compared with an increase of 3.4% last year. The increase in comp sales for the fiscal first quarter was attributed to a slight increase in the average transaction amount, partially offset by a slight decrease in the number of transactions.
  4. Gross profit for the fiscal first quarter was approximately 38.8% of net sales compared to approximately 39.5% of net sales in the corresponding period a year ago.

Capital Ladder recently discussed what continues to be of great concern for investors in shares of BBBY, gross profit. In our latest publication we noted the following:

Gross margins continue to deteriorate for the retailer on a year-over-year basis. Gross profit for 2013 was approximately 39.7% of net sales compared to approximately 40.2% of net sales for the full year of 2012. The trend in gross profit performance continues to be a long-standing issue with Bed Bath & Beyond as last year's performance and the most recently ended period indicates. Now let's take a look at the newly issued guidance for the current quarter.

It is unfortunate, but it does appear as though issues surrounding gross profits continue to weigh on the company with, seemingly, no end in sight. In the most recent quarter, gross profits breached the 39% threshold for the first time since the financial crisis of 2008. This broadly overlooked factor indicates something very disturbing about today's consumer vs. the consumer prior to the financial crisis. Additionally, it indicates that in spite of retailers' best efforts to boost omni-channel capabilities and offerings, the fixed cost structure related to store operations will likely not be of benefit to retailers going forward.

Bed Bath & Beyond's gross profit margin came in at 38.8% in the first quarter due to a variety of factors. First and foremost, hindering the company's gross profit performance is the "coupon effect". The consumer continues to beckon retailers for more and more discounts and/or coupons. In the latest quarter, BBBY pointed to greater amounts of coupons being used by the customer and in higher dollar amounts per transaction. Another factor that weighed on the company's gross profit performance during the first quarter was the impact of direct to consumer shipping.

The "Beyond Store", as in-store associates recognize the firm's e-commerce channel, contributes a great deal of revenue to Bed Bath & Beyond's total quarterly and annual revenues. With thousands of items on-line that can't be positioned into its retail square footage, the Beyond Store assists in-store associates when capturing the consumers' dollars. If a customer in the store wants a particular blender, but the store doesn't have it in-stock or the company doesn't offer that color in the stores, a store associate can offer to direct the customer to any in-store kiosk and explore the Beyond Store to see if that product is available on-line. While the upside of this customer friendly operation is that Bed Bath & Beyond can further satisfy the customers' desired purchase, the downside is that many times the direct-to-customer shipping cost lowers the margin of this sale. We would recognize Bed Bath & Beyond's free shipping threshold to be at 30% of total direct-to-customer shipping transactions presently (proprietary data collected by Capital Ladder Advisory Group, subscription required).

In summation, it is clear that two variables currently affecting the company's total gross profit performance will likely not abate any time in the near future. This shift in consumer spending habits coupled with increased omni-channel competition will likely persists for the foreseeable future. Moreover, Bed Bath & Beyond has stated clearly, that it has desires to continue to invest in the company's various sales channels going forward which will add expenses to the company's cost structure year-over-year.

Through the investments we have made, and will continue to make, our customers can purchase products either in store, online, or through a mobile device. Also, we have the developing ability to have customer purchases picked up in store or shipped direct to the customer from our distribution facilities, stores, or vendors". These compounding investments have lingering affects presently; for the most part, they are not showing their intended profit value for shareholders of BBBY presently. With that said, investing is a long-term process.

In the opinion of Capital Ladder Advisory Group, Bed Bath & Beyond's strongest assets are its retail square footage space that is governed by a merchant-driven, dollar/sq. ft. merchandising strategy. Unlike some of BBBY's peers in the department store and/or big-box retail space, the company employs the use of most all of its store format for the placement and sale of product. Any additional space is used for customer walkways and storage space. It's not often that you won't see shoppers navigate gingerly around store fixtures such as 4-way islands, 8-way islands, dump bins and product racks where most retailers maintain larger, wider aisles/walkways for ease of walking. But this is what separates Bed Bath & Beyond from its competition. At every turn and pivot of a shopping cart, the consumer is presented with a variety of product choices. Products are not just down specific aisles or contained within the respective product department, they are in the main walkways/race-track, up scaled up columns, and in dump bins outside of the product's essential department for presentation purposes and impulse shopping accessibility. Too put it mostly simply, Bed Bath & Beyond uses almost every sq. ft. of selling space possible for presentation and sales.

Department managers and Side-Assistant Store managers are driven to drive higher dollar/sq. ft. performance within their respective areas of management. All fixtures are scanned monthly to obtain sales performance and inventory levels throughout the store. Store management is dedicated to increasing sale performance by consistently merchandising the store to appreciate sales performance. If a particular product is not selling well in a particular department location, managers are encouraged to modify the product's placement and/or employ greater merchandising techniques to increase the sales of said product. In order to accomplish increasing sales goals, store management is empowered to merchandise without the use of plan-o-grams more often than not. Additionally, most store locations carry products that fit the surrounding community demographics in order to most specifically carry merchandise the demographic would be inclined to purchase.

Currently, Bed Bath & Beyond boasts over 42 million sq. ft. of retail space with its 1,504 stores. The company will continue to grow its brick-and-mortar footprint alongside its omni-channel sales platforms, but the capital expenditures associated with these developments will continue to weigh on profitability. The convergence of higher expenses and increased couponing from the consumer does not bode well for gross profit improvement even with in-store management's dedication to growing revenues through in-store merchandising and customer service efforts.

Capital Ladder believes the company's dedication to returning profits to shareholders remains relevant to investing in shares of BBBY despite lower gross profits and as free cash flow remains strong. Recently, Bed Bath & Beyond's Board of Directors had authorized a new $2.0 billion share repurchase program and expects that the new share repurchase program will commence after the completion of its existing share repurchase program.

Bed Bath & Beyond offered somewhat conservative guidance for the second quarter and full year on their earnings conference call on July 7, 2014.

  1. For the fiscal second quarter, BBBY is modeling comparable sales to increase in the range of 1% to 3%. For the full year, the company is modeling comparable sales to increase by approximately 3%.
  2. Consolidated net sales are modeled to increase by approximately 2% to 4% for the second quarter and approximately 4% for the full year.
  3. Based on these and other planning assumptions, BBBY is modeling net earnings per diluted share to be approximately $1.08 to $1.16 for the fiscal second quarter of 2014. (Analysts have pegged the company to earn $114 for the second quarter according to Capital IQ)

While guidance seems understated or achievable for the second quarter of 2014, here is what Capital Ladder is fearful of for investors with this stated guidance. Most investors of scale or institutional investors are now looking more closely at Bed Bath & Beyond's gross profit performance since it is continuing to decline and affect total earnings performance. Fiscal Q2 is Bed Bath & Beyond's heaviest quarter with regards to cost of goods; the buying quarter in which the company dramatically increases spending on merchandise while increasing inventories, warehousing and logistics expenditures. Given the heavy discounting of merchandise sold during Q4 2013 to retailers by vendors/wholesalers and with results underperforming vendor expectations, these vendors are less likely to replicate the deals they levied to retailers this year. The effect of these negotiations between vendors and retailers taking place right now, in preparation for inventory building ahead of the holiday shopping season, could materially affect gross profitability during the second quarter for Bed Bath & Beyond. Capital Ladder has discussed sell-in pricing with a great many vendors/ wholesalers over the last several months. We are increasingly finding that vendors/wholesalers are not as willing to reduce their sell-in prices to the extent they had done in 2013. Some vendors have indicated that they are more willing to sell fewer units to retailers at stable prices, while reducing their production expenses, than to cut their sell-in prices and maintain high production levels with high costs associated with production. In short, vendors are not as willing to take the brunt of discounts to the consumer; they want the retailer to share in more of these costs this year.

Capital Ladder does not consider Bed Bath & Beyond to be the optimal investment presently, even with the lower valuation that the stock is yielding. Secondly, we do not believe the company to be a takeover target in any way. While the media may point to such an event as being probable, we share a very different opinion with recognition to the stock price valuation being even lower in years past, yet no such acquisition or takeover took place at even lower valuations for shares of BBBY. Additionally, the company has embraced a new strategy with regards to taking on debt. Before last month's announced debt offering, the company hadn't added any debt to its balance sheet in roughly 20 years. What may have once proven to be an attractive leverage buyout candidate, this notion utterly evaporates with this debt offering by Bed Bath & Beyond. For all the company's measures taken to address the company's share price, they do very little with regards to getting customers in the stores or onto their e-commerce site.

Bed Bath & Beyond is not alone in their struggles to contend with the tightened purse strings of the consumer. Target recently lowered their Q2 2014 outlook citing conservative consumer spending trends persist . Given all the aforementioned headwinds mentioned, we see limited upside potential in shares of BBBY. Current shareholders may be rewarded longer term, but we would not be adding shares of BBBY to our portfolio at this time.

Disclosure: The author is long BBBY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. I am long shares of BBBY through a stock grant package which dates back to 2004