Bed, Bath and Beyond: Housing Recovery Play

Bed, Bath, and Beyond (BBBY) is a well known retailer of home furnishings, operating about 860 stores in the United States. The company also runs three smaller concepts: Christmas Tree Shops (39 stores), Harmon (40 stores), and buybuyBABY (8 stores). BBBY is a best in class retailer with outstanding supply chain, inventory, and sales mix management. This is spelled out in the company’s historical results: annual 16% revenue and 20% earnings per share growth over the past 5 years.

The company also has one of the strongest financial underpinnings in the retail world, let alone the home furnishings market. Bed, Bath, and Beyond has almost doubled their store base without taking out a penny of debt over the last 5 years. Free cash flow has historically been about 9% of revenue and increased 11% per year. Gross and operating margins had steadily improved up to last year. The 5-year average return on tangible capital is 65% - an astounding figure for retail, which requires large amounts of hard capital investment.

The home furnishings market is quite competitive. Bed, Bath, and Beyond’s primary direct competitor is Linens N’ Things, but major department stores like Sears and even discount retailers like Wal-Mart (WMT) and Target (TGT) compete in this space. BBBY’s respected name brand, positioning in the up-market niche, incomparable selection, and financial health give it defendable advantages against these competitors.

There is some concern on Wall Street that the store base has reached saturation. To MagicDiligence, this seems incorrect. The company estimates that the U.S. can support 1,300 stores. From the current count of 860, that’s still a 34% potential increase in stores. And we believe 1,300 might be low - Best Buy recently raised it’s saturation point to 1,800 from 1,400, and we don’t see why Bed Bath can’t support a similar store base. The company also recently opened it’s first and only Canadian store, an untapped market. And last, it’s smaller concepts have miniscule reach and can likely be expanded to several multiples of their current store count.

Bed, Bath, and Beyond has traded at a P/E multiple in the mid-20s for most of this decade. Today it’s at 13. The problems are not company specific. The historic housing slump and credit crunch hit the company directly in it’s gut. Profitability has declined with same store sales growth. However, Bed Bath has performed extremely well through the slump relative to its competitors. When the housing market does turn, this is a stock that can shoot up in short order.

Disclosure: Author owns shares of BBBY