Bed Bath & Beyond: Look Beyond The Obvious Dip

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About: Bed Bath & Beyond Inc. (BBBY)
by: Siddharth
Summary

Q2 results and commentary.

Taking cue from buybacks.

Let's not overdo the sell on Bed Bath & Beyond.

Bed Bath & Beyond (NASDAQ:BBBY) reported second-quarter results that further depressed sentiments around a turnaround in operations. The company downgraded its EPS guidance from $4 to $3 due to lower-than-expected comp figures and an 11 cent impact from one-time items. With the stock down nearly 15% (at the time of writing), I think investors should look at the prospect of finding cash in trash instead of emphasizing the lack of improvement in business fundamentals. If there is a sustained dip greater than these levels, the stock is likely to trade at atrociously cheap multiples with a decent dividend yield that is likely to be sustainable.

Q2 Results and Commentary

If I had to sum up the message from the earnings call in one sentence, I would put it this way. A fog of uncertainty awaits the company and this could weigh on the value of the stock. Analysts tried to understand whether second-quarter operating margins could mark the bottom and therefore would hover around 5.7% henceforth. The company though was non-committal. It maintained that operating margins beyond this year will depend on industry conditions. I think this is just another way saying - we are not really sure if the ongoing onslaught in our industry has approached its expiry date yet.

Net sales were down 1.7% to $2.9 billion as comparable sales fell wider than expected at 2.6%. Gross margins compressed 130 basis points year-over-year to 36.4% on account of higher shipping expenses associated with online sales and lower merchandise margin reflective of competitive pressures within the industry. The company's e-commerce revenues which represent around 15% of total sales were robust and increased 20%.

Based on my projections, I am reasonably convinced that the company's free cash flow buffer is good enough to make interest and dividend payments (at current yields) for the next three years. I have assumed a 1.5% decline in sales. Based on my cost of sales and SG&A assumptions, operating margins were 5%, 4.4%, and 4% in the years 2018-2020. I have maintained my tax rate projection at expected 2017 levels of 37%. The company stated in the earnings call that capex is likely to be between $350 million and $400 million for the foreseeable future. I have taken the midpoint of that range for my calculations. Bed Bath & Beyond's free cash flows are above the $200 million mark in all the three years projected. Therefore, it should have no problem in meeting interest and dividend payments of $80 million each.

I am fairly agnostic about the timing of buybacks given that most retailers are ruing their repurchases at expensive multiples in the past. But in case of BBBY, it may be indicative of a turnaround. Against a veiled criticism about the $56 million repurchase (given the stock is down today) this quarter, the company mentioned that its capital allocation priorities dictate directing a part of the remaining cash flows after dividends towards buybacks. But there is weight in the analysts' assertion that company fundamentals probably deteriorated more than what management had come to expect. The buffer available for buybacks is declining. I therefore think the firm is likely to be cautious and resume buybacks only if it expects stabilization in business conditions.

Conclusion

I understand that recent articles have argued for accumulation on this ticker and today's price action negates that assessment. But today's price action is probably a case of overdoing the sell on the firm. For investors still willing to wait, I think the next buyback can be taken as a cue to accumulate Bed Bath & Beyond.

Note: Company related data have been sourced from company filings

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Disclosure: I/we 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.