Bed Bath & Beyond's Gross Profit Looks Worrisome

| About: Bed Bath (BBBY)
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Gross margins look to continue to deteriorate.

Consumer discretionary spending is not what it used to be.

Expansion of retail space seemingly not a savior and could be curtailed going forward.

After the closing bell yesterday, Bed Bath & Beyond (NASDAQ:BBBY) reported fiscal first quarter net earnings per diluted share of $0.93. 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 comparison sales and approximately 76% was primarily from new stores and Linen Holdings. Shares of BBBY fell sharply on these results as the earnings and sales came in at the low end of the company's guidance while other metrics disappointed investors as well.

During the first quarter, comparison sales increased by approximately 0.4% compared with an increase of 3.4% last year. This achievement was well below the guidance offered for same-store-sales on the fourth quarter 2013 conference call. Management had modeled guidance for the first quarter of 1%-2.5% same-store-sales growth. The increase in comparison 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. What this indicates is that BBBY may be experiencing lower foot traffic in stores and/or on-line.

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. This decrease in the gross profit margin as a percentage of net sales was primarily attributed to an increase in coupon expense resulting from an increase in redemptions and a slight increase in the average coupon amount, an increase in net direct to customer shipping expense, which was impacted by the company's free shipping threshold, as well as a shift in the mix of merchandise sold to lower-margin categories. If we analyze these factors, we come away with the understanding that the consumer is conscious about the amount they are spending on discretionary goods. The consumer is keenly aware and now has greater tools to locate the best deals for the goods they desire.

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.

For the fiscal second quarter, the company is modeling comparable sales to increase in the range of 1% to 3%. For the full year, BBBY is modeling comparable sales to increase by approximately 3 percent. Consolidated net sales are modeled to increase by approximately 2% to 4% for the second quarter and approximately 4% for the full year. Net earnings per diluted share are modeled to be approximately $1.08 to $1.16 for the fiscal second quarter of 2014. Most analysts had expected net earnings of $1.20 for the second quarter of 2014. For all of fiscal 2014, BBBY continues to model a mid-single digit percentage increase in net earnings per diluted share.

Through the existing share repurchase program, during the fiscal first quarter, the company repurchased approximately 4.2 million shares for approximately $273 million.

During 2014, the retailer now anticipates opening approximately 22 new stores company-wide with the potential of up to six additional stores before the end of the fiscal year. It is important to note that this expectation is a reduction from the previous guidance whereby the company had outlined plans to open 30 new stores in fiscal 2014.

Unfortunately, there are many headwinds, which Bed Bath & Beyond is facing presently and possibly for the foreseeable future. The consumer, very simply put, is spending less on discretionary items than in the past. When the consumer is spending on discretionary items, they are looking for the best deals at the greatest convenience in many cases and as indicated by the company's management team directly. The coupon-effect has taken hold in the consumer's mind and mature retailers are having to invest heavily in order to maintain and grow their consumer base.

Based on recently updated second quarter guidance and the continued deterioration in gross profit at Bed Bath & Beyond, we would not feel shares are attractive even at the currently depreciated valuation. We would, however, take a further look at the company's prospects and results through channel sales data over the next several months and assume the share price will remain under pressure during this stated period. Given the current valuation, the stock is trading near the lower end of its historical price to earnings ratio between 12-14 times earnings. Therefore, we would not feel comfortable shorting shares of BBBY at these levels either as the company maintains its strong free cash flow performance and consistent share repurchase program, which serves as a backstop for mature retail stocks in many instances.

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.

Additional disclosure: I personally own stock options granted to myself in 2004 for contractual work performed for the company over a 2-year period.