Bed Bath & Beyond: Down But Not Out

| About: Bed Bath (BBBY)


Slowing growth a temporary issue.

Current valuation represents a sizeable discount to competitors.

Online competition still a threat, but Bed Bath & Beyond is staying competitive.

Online push, store expansion, and low valuation make Bed Bath & Beyond a good buy.

Slow Growth And Margin Compression

Bed Bath And Beyond Inc. (NASDAQ:BBBY) performed well during the economic recession. In 2008, gross, operating, and net income fell, but revenue continued to grow. In 2009, the company quickly rebounded with an impressive 40% plus growth in net and operating income. In fact, Bed Bath & Beyond has been able to grow net income over 40%, in the last 5 years.

Growth Rates 2008 2009 2010 2011 2012 2013
Net Revenue 2.26% 8.61% 11.88% 8.46% 14.89% 5.40%
Gross Profit -1.78% 11.66% 12.93% 8.50% 11.65% 4.03%
Operating Profit -19.58% 45.52% 31.38% 21.72% 4.45% -1.44%
Net Income -24.46% 41.14% 31.88% 25.05% 4.88% -1.49%

Bed Bath & Beyond has accomplished this growth without sacrificing substantial margin.

Margins 2007 2008 2009 2010 2011 2012 2013
Gross 41.5% 39.9% 41.0% 41.4% 41.4% 40.2% 39.7%
Operating 11.9% 9.4% 12.5% 14.7% 16.5% 15.0% 14.0%
Net 8.0% 5.9% 7.7% 9.0% 10.4% 9.5% 8.9%

Since 2007, gross profit margin has only declined 181 basis points. Even as gross margin has declined, operating and net profit margins have increased by 215 and 91 basis points, respectively. The reason gross margin has declined is because of Bed Bath & Beyond's commitment to coupons and discounts.

On the 2014 Q1 conference call, Steven Temares, CEO, said

This decrease in 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...

Margin compression is never good, but Bed Bath & Beyond currently enjoys a superior margin position relative to competitors.

Margin Comparison Operating Profit Net Profit Margin
Bed Bath & Beyond Inc. 13.8% 8.7%
Williams-Sonoma, Inc. (NYSE:WSM) 10.4% 6.4%
Pier 1 Imports, Inc. (NYSE:PIR)
9.4% 5.7%
Kirkland's Inc. (NASDAQ:KIRK)
5.3% 3.2%
Restoration Hardware Holdings Inc. (NYSE:RH)
8.0% 1.3%

Bed Bath & Beyond has a 230-basis point net profit margin edge over close competitor Williams-Sonoma. The retail environment has seen a significant increase in competition from online retailers. Bed Bath & Beyond's superior margin position gives it the ability to compete more intensely with online and off-line retailers. Recently, management has decided to aggressively expand its retail business. Management is investing heavily in store openings, store renovations, and e-commerce offerings.

Positioning For Growth

In the 2013 10-K, management writes:

Capital expenditures for fiscal 2014, principally for information technology enhancements, including omnichannel capabilities, new stores, existing store improvements, and other projects are planned to be approximately $350 million...

The $350 million capital expenditures would represent an increase of over 10% from 2013 levels ($317 million). In 2014, Bed Bath & Beyond has already opened 4 new stores. It plans on opening another 22 stores and has the option to open an additional 6 more stores. Management's physical retail expansion is an important piece of future revenue growth, but online efforts are more desperately needed.

Great Opportunity For Improvement

According to Laura Champine, Bed Bath & Beyond has a 24% market share in the $46 billion home furnishing market (based on U.S. Census Bureau). Although it is the market leader, Bed Bath & Beyond doesn't have a sizable market share of the growing home furnishing and furniture e-commerce industry. According to a Nasdaq article, eMarketer estimates home furnishing and furniture online sales could grow to $31 billion by 2016. This would represent a growth of 75%, from $17.7 billion (2012). Additionally, health and personal care products are expected to reach $19 billion by 2016. The $19 billion would be a growth of $9 billion from 2012 ($11 billion).

Although lagging, Bed Bath & Beyond has positioned itself nicely to experience e-commerce's rapid growth. It runs three different e-commerce sites, with two of them positioned to take advantage of eMarketer's rapid growth estimates. Bed Bath & Beyond runs (personal and health care products), (baby products), and its flagship (home furnishing and furniture). Harmon discount and its namesake website should experience robust growth over the next several years. Laura Champine, analyst for Canaccord Genuity, wrote about the e-commerce business prospects improving estimates:

[Bed Bath & Beyond] has launched the first of two new e-commerce sites, and we are raising our estimates as we incorporate growth of the online channel into our model, according to Internet Retailer.

Bed Bath & Beyond needs a growth driver, and its lack of e-commerce represents a significant area of growth. Management's expansion plans are only half the reason Bed Bath & Beyond is such a good buy.

Low Valuation Compared To Peers

Investors viewed the company's recent slowing growth as a sign of trouble. This resulted in a significant stock decline (25%), over the last several months. The sell-off appears to be an overreaction. Currently, Bed Bath & Beyond is cheaper than most direct competitors, based on a P/E and EV/EBITDA basis. Even based on P/S, they are in the middle of the pack.

Valuation Metrics P/E(TTM) P/S(TTM) EV/EBITDA*
Restoration Hardware Holdings Inc. 199.8 2.2 23.8
Williams-Sonoma, Inc. 24.9 1.5 10.8
Kirkland's Inc. 21.8 0.7 5.7
Pier 1 Imports, Inc. 15.6 0.8 6.9
Bed Bath & Beyond 12.4 1.0 6.1

Data: Yahoo Finance- Key Statistics *EV (Enterprise Value)

So, why is Bed Bath & Beyond selling for such a low valuation?

Revenue Growth Rates 2011 2012 2013
Restoration Hardware Holdings Inc. 24.1% 24.5% 30.0%
Williams-Sonoma, Inc. 6.2% 8.7% 8.5%
Bed Bath & Beyond Inc. 8.5% 14.9% 5.4%
Pier 1 Imports, Inc. 9.8% 11.2% 4.0%
Kirkland's Inc. 3.6% 4.2% 2.7%

Data from: Google Finance

The company's sales growth has slowed. However, Kirkland and Pier 1 have slower growth rates and are trading at much higher multiples. Investors are unjustly punishing Bed Bath & Beyond. The market is discounting management's growth plans. This has made Bed Bath & Beyond an attractive buy. It has better margins and a higher growth rate than Pier 1 and Kirkland. As a result, it should be selling at similar or a better multiple.

If Bed Bath & Beyond were trading at a P/E of 15, the company's stock would be trading around $71. That would represent a gain of over 20% from the current market price. The company only has to grow revenue in the mid-to-high single digits to improve investor sentiment. The improved investor sentiment should lead to multiple expansion. Bed Bath & Beyond is already growing at 5.4% and would need to increase revenue by only a few percentage points. The company's low valuation combined with the improved e-commerce position makes this a good low-risk, high-reward investment. Although a good buy, Bed Bath & Beyond does face some headwinds.

Showrooming A Real Risk

One of the major disadvantages to shopping online is not being able to feel and see the product. To remedy this situation, consumers go into stores and test products then buy online. This is known as showrooming. Certain products lend themselves well to showrooming. Electronics is a great example. The product offered online and in-store are going to be exactly the same. Although not a significant threat yet, showrooming could be a potential problem to the company's expansion plans. According to Placed survey, consumers were 27% more likely to visit Bed Bath & Beyond and then purchase on Amazon (NASDAQ:AMZN). Bed Bath & Beyond will have to compete heavily on price and increase the value of their in-store experience to combat showrooming. Their in-store only coupons and discounts should help reduce showrooming. However, Bed Bath & Beyond and other brick-and-mortar retailers still need help competing, with online retailers.

Deliver A Great Product At An Affordable Price

With the passage of the Market Place Fairness Act, all e-commerce sites would be forced to collect sales tax on their products. Based on Anthony Chukumba's estimates, this law would eliminate a 5%-10% price advantage, which Amazon currently enjoys. The Market Place Fairness Act may take awhile to pass but there is strong support for such a law. Even without the passage, Bed Bath & Beyond has been able to stay competitive with Amazon. According to an ABC News report, Bed Bath & Beyond was 6.5% cheaper, on average, than Amazon. This is before any coupons or discounts which would make Bed Bath & Beyond much cheaper.

Great Growth Opportunity And Low Valuation Make Good Buy

Recently, Bed Bath & Beyond has experienced a slowdown in growth. As a result, the stock is down over 25% in 2014. Investors are worried about growth and margin compression. Yet, Bed Bath & Beyond has better margin than most direct competitors. This gives the company the ability to compete fiercely on price. Although not ideal, some margin compression is expected in such a competitive market. To keep things in perspective, margin compression has been slow and has only been 181 basis points, from 2007-2013.

Management has decided to expand their retail footprint and renovate their existing retail space. They are investing heavily in e-commerce to help bolster their lackluster online sales. This couldn't be at a better time. Home furnishing and furniture e-commerce sales are expected to nearly double in the next few years. Additionally, Harmon Discount is well positioned to grow in the rapidly expanding personal care and health e-commerce industry.

The recent sell-off has given investors a great buying opportunity. Bed Bath & Beyond's shares are priced at a discount to many of its peers. Bed Bath & Beyond has experienced a temporary slowdown, but is positioned for a nice recovery.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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