Bed Bath & Beyond Is Having A Sale

| About: Bed Bath (BBBY)

Summary

BBBY is selling at rock bottom prices as Amazon has sent investors running for the exits.

BBBY will survive due to an advantage it has over Amazon.

The company is making money, has growing revenues, and positive cash flows.

Read This First

If you believe that Amazon (AMZN) is going to be the only retailer alive in 10 years then you should save yourself some time and not read any further. The case I’m going to make is based on the premise that some retailers will survive in the era of Amazon. More specially, I’m going to make the case that Bed Bath & Beyond (BBBY) will be one of those retailers and, as such, is currently trading at levels that represent a bargain.

A Bit of Background Knowledge

The company’s first two stores opened in 1971 and primarily sold bed linens and bath accessories. The “and Beyond” part of the name would be added in 1985 when the company started selling other home furnishings. Today the company has 1,546 stores (plus an online presence)[1] across North America and sells just about everything you would need to furnish your home: things like pillows, shower curtains, blenders and couches. The company likes to think of itself as the go-to place when shopping for “heart-related life events”. These are the events that represent a pivot in your life: events like a marriage, a new house, or going off to college.

The company operates a number of different brands including buybuyBaby, Cost Plus, Chef Central and PMall. All of these brands operate in generally the same market space and thus there isn’t a huge need to differentiate between them.

The Current Situation

Saying the company has had a rough couple of years might be an understatement. The company’s stock peaked around $80.00 all the way back in 2014 and has been in a pretty steady decline ever since. Today it trades around $21.25.

Source: Seeking Alpha

The company has a dividend of $0.15 per quarter[2] resulting in a 2.82% annual yield and the company has been aggressively buying back it’s stock. Roughly 34% of the outstanding shares have been repurchased within the past 5 years.

Source: BBBY 10-Ks from 2013 to 2017

The Historical Numbers

I’ve calculated the numbers below with some pretty conservative assumptions. I have, for example, capitalized the company’s leases on the balance sheet, assumed that outstanding gift card are part of the capital structure (they are, after all, effectively short-term loans that roll over continuously), and assumed that all capex is maintenance capex (despite having reason to believe that at least 40% of capex is growth related[3]).

Return on Capital Employed (ROCE)

Source: BBBY 10-Ks from 2014 to 2017 and author's calculations

My personal goal for ROCE is 15%. BBBY manages to play hopscotch with that number depending on the assumptions made, but I think it’s safe to say that the company is basically at that threshold. It’s not blowing past it (which would be nice) and it’s not obviously failing to meet it (which would be bad). I take comfort in knowing that my assumptions are conservative. If, for example, I didn’t treat the gift cards as part of the capital structure the numbers would look even better: 2017’s Min/Max would be 14.35% to 17.09%.

Overall: I’m would be content with these numbers from any company.

Free Cash Flow Return on Capital Employed

Source: BBBY 10-Ks from 2014 to 2017 and author's calculations

My personal goal here is to have at least an 8% FCFROCE… and BBBY is safely above that threshold across the board. There is a noticeable trend downward which is concerning but expected; we know that BBBY is taking heat from Amazon and the company has responded by lowering prices which has resulted is a squeeze to BBBY’s bottom line. Its also important to note the following:

  • I’ve assumed that all capex is maintenance (which we know isn’t the case as the company is investing heavily in it’s digital presence). Again, I take comfort in knowing that these numbers are being posted under conservative assumptions. If we assumed that 20% of the capex is growth (latest numbers suggest it’s actually 40%) the FCFROE for 2017 improves to a range of 9.04% to 10.70%
  • Revenue increased every year during the last 5 years. Meaning that people are still shopping at BBBY:

Source: BBBY 10-Ks from 2013 to 2017

  • BBBY is in a transition period as they’re rapidly trying to build a robust online presence. Falling free cash flow numbers during this period should be expected.

Overall: The numbers are good, but the downward trend is concerning. When taken in context though I think I’ll still be able to sleep at night.

Growth Metrics

Source: BBBY 10-Ks from 2014 to 2017 and author's calculations

I always look at the growth metrics when looking at a company. Mostly it’s because I’m on the lookout for “forever” companies: those that I can buy and hold forever (who isn’t?). Companies which have good historical numbers and solid growth metrics are good candidates to be “forever” companies. BBBY is not a “forever” company. The company’s growth metrics are mediocre at best. But that’s what I expected when choosing to look at a traditional retailer in 2017! Truthfully, I’m surprised the growth numbers aren’t negative across the board based on how the stock has performed and the rise of Amazon. Operating income, free cash flow, and book value (all on a per diluted share basis) have grown at a CAGR of +2.00% over the last 5 years. Not terribly exciting numbers for a company, but certainly exciting numbers for a company that’s being valued as if it’s on its way out! Tangible book value is the only metric that has a negative CAGR. The big reason for that is because in 2015 BBBY borrowed a bunch of money to buy back shares. The increase in liabilities (and the subsequent drop in equity) more than offset the gains created by reducing the number of stocks outstanding.

Overall: Not good if you’re looking for a “forever” stock… but pretty decent given that BBBY is a traditional retailer competing with Amazon.

Price is What You Pay, Value Is What You Get

If you buy a share of BBBY today you’ll pay about $21.25.

Here’s what you get[4]:

  1. A company that is trading at 4.5X last years earnings and 1.5X tangible book value.
  2. A company that has rising revenues and positive free cash flows
  3. A company that is rapidly growing its online presence (but keeping the brick and mortar footprint)

Source: BBBY 10-Ks from 2014 to 2017 and author's calculations

This company is cheap. No doubt about that. The question then is: Why is it cheap? My answer is simple: Amazon has sent investors running away from traditional retailers. Some traditional retailers absolutely deserve to be where they’re trading, but I don’t think BBBY is one of those companies.

Why I think BBBY will exist in the future

I think Amazon’s weakness is that you cannot touch/feel/hold merchandise before buying it. This isn’t a big concern for a lot of the things Amazon sells: books, computer cables, and electronics[5]. A book from Amazon is guaranteed to feel exactly the same as a book from a traditional retailer. A computer cable from Amazon is guaranteed to work just as well as one from a traditional retailer. Where Amazon loses its advantage, in my humble opinion, is when it comes to selling a lot of the things BBBY sells: things like towels, pillows, pots and pans. These are the kind of items whose qualities are hard to quantify and vary widely from brand to brand and model to model. They have to be touched to be understood. The thickness of a towel, the squishiness of a pillow, or the comfort of a chair cannot be understood by looking at a picture or reading an item’s description.

Admittedly, I use Amazon. In fact, I love using Amazon! But I only use it for items that I’m already comfortable with: things like toothpaste (I’m a crest man), head and shoulders shampoo (almond scented if available), and books (both digital and hard copy). What I don’t buy on Amazon are things that have a high chance of not being exactly what I want: things like towels, pillows, and chairs. Would you buy a chair without sitting in it first? I wouldn’t, at least not an expensive one, and I’m willing to bet that other people wouldn’t either. That’s why I think BBBY is still a viable business.

I should also point out that the importance of having an online presence is not lost on BBBY’s management. They are rapidly trying to build an “omni-channel” environment where the experience online is seamlessly integrated with the in-store experience[6]. For example, buying something online and then returning it in-store should be seamless. Same goes for buying something online and then picking it up at the store. 40% of the capex for the last two quarters was related to building the online platform and sales are up 20% year-over-year[7]. Needless to say, BBBY is well aware of the need to be online and appears to be rapidly ensuring they carve a place out for themselves.

Other Things to Know

Just some other quick things to note:

  1. No supplier represents more than 10% of sales (not by a long shot).[8]
  2. The company is okay on the shareholder friendliness front. I think the management and board make too much money, but it’s not so much that I would stay away. It’s more of an annoyance than anything else.
  3. The company’s liabilities-to-equity ratio is 2.63. Ideally it would be below 2.00 but alas its not. 2.63 isn’t terrible though and the $21.25 price tag makes up for it.

Source: Author's calculations

Not Mr. Right, just Mr. Right Now

I’m not saying that Bed Bath & Beyond is a “forever” stock. The company operates in the perpetually competitive retail sector and has no obvious economic moat[9]. I would always prefer a company that had better growth metrics, less competition, and less leverage. What I am saying, however, is that BBBY is being priced as if it won’t be around for much longer and I think that’s a mistake. The company has growing revenues, positive cash flows, and is working to ensuring that it has a robust online presence. More importantly, I think BBBY has an advantage over Amazon when it comes to selling the things BBBY has been historically good at selling. With that in mind, I think $21.25 is a bargain price.

I’m going to start buying a position over the next 90 days (I like to “average” the price of my position by buying it in pieces). If this company was trading at $30 I would be on the fence as to whether my margin of safety was large enough… so that’s going to be my exit price unless things change with the company.

- Mike


[1] See page 7 of the latest 10-K for store count.

[2] See page 12 of the latest 10-Q for dividend information.

[3] From the latest 10-Q report: “In the first six months of fiscal 2017, more than 40% of the capital expenditures were for technology projects including investments in the Company’s digital capabilities, and the development of new systems and equipment in stores.” Note: I did not find similar wording in previous 10-Ks.

[4] MCAP = Market Capitalization, FCF = Free Cash Flow, EV = Enterprise Value, OI = Operating Income, BV = Book Value, TBV = Tangible Book Value, P/E = Price-to-earnings ratio

[5] Check out Amazon’s “Best Sellers” page. Notice how there isn’t an advantage to touching/feeling/holding these items before buying them?

[6] See page 5 of the latest 10-K for an outline of the company's digital strategy.

[7]

  1. From the latest 10-Q report: “For the three and six months ended August 26, 2017, comparable sales consummated through customer facing digital channels increased in excess of 20% over the corresponding periods in the prior year, while comparable sales consummated in-store declined in the mid-single-digit percentage range.”
  2. And from the latest 10-K: “For fiscal 2016, comparable sales consummated through customer facing digital channels increased in excess of 20% over the corresponding period in the prior year, while comparable sales consummated in-store declined in the low single-digit percentage range…”

[8] From the latest 10-K: "In fiscal 2016, the Company purchased its merchandise from approximately 10,800 suppliers with its largest supplier accounting for approximately 2% of its merchandise purchases..."

[9] Based on the latest 10-K, the company seems to think it’s advantage is “[presenting] an exciting and engaging assortment of products to its customers…” <-- That doesn’t sound like a real economic moat to me.

Disclosure: I am/we are long BBBY.

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.

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