Bed Bath & Beyond: Fit As A Mallee Bull

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About: Bed Bath & Beyond Inc. (BBBY), Includes: HD, HOME, TGT, WSM
by: Christian Stoyanov
Summary

Will brick-and-mortar stores go away for good?

If BBBY continues it's cost-cutting strategy an upside of the stock is inevitable.

With a new online look and inovative in-house brands Bed Bath & Beyond can turnaround.

Recommendation

Bed Bath & Beyond (BBBY) is going through a big market correction since April 2015, but can the company turn things around?

The core investment thesis is that BBBY can inverse its position with its new future outlook and strategy. Although I do expect a mediocre 10k report on the 10 th of April, I also think that slowly and steadily BBBY can regain its former position by implementing several new strategies. By cutting costs, closing underperforming stores, growing its digital market and decreasing its inventory, I believe BBBY can actually get ahead of the game or at least stabilize.

Company Background and Overview

*Picture taken directly from latest 10Q presentation

Bed Bath & Beyond is an American chain of domestic merchandise retail stores in the United States, Puerto Rico, Canada and Mexico. BBBY also has several acquisitions under its belt:

  • Harmon Stores – Cosmetic, health and beauty retailer.
  • Christmas Tree Shops – Bargain stores, selling food, toys, household furnishings, and Christmas decorations.
  • Buy Buy Baby – Chain of stores that sell clothing, strollers and other items for use with infants and young children. Considered one of BBBYs best acquisitions.
  • Cost Plus, Inc. – Specialty/import retail stores, selling home furniture, decor, curtains, rugs, gifts, apparel, coffee, wine, craft beer, as well as international food products.
  • Linen Holdings – Distributor of bath, bed, table linens, other textile products, and amenities to customers in the hospitality, cruise line, food service, healthcare, and other industries.
  • One Kings Lane – home decor business that operates a furniture and home accessories sales website. Acquired on a bargain for less than $30 million in 2016 by Bed Bath & Beyond after being valued at over $900 million in early 2014.
  • PersonalizationMall.com – Offering personalized gifts for men, women.

Today, BBBY’s growth in revenues for the last 3 years (including TTM) is around 0.6% CAGR. With its 18 lab stores across the country the company is well positioned to understand its customers wants and needs and make the necessary changes to its shops.

BBBY is trading right now at the lowest valuation compared to its peers, with a 4.7 EV/EBIT ratio and has been overlooked by the market because of its low operating margins (4.4% TTM) and unimpressive year-to-year results.

Recent Results

*Picture taken directly from latest 10Q presentation

According to their numbers BBBY has continued showing below expectation results. Although the company increased their net sales by 2.6% quarter to quarter, in the last 5 years (Including TTM) BBBY has decreased its revenue growth from 3.3% per year to a mediocre 0.71% for the trailing twelve months.

Recently BBBY has taken the necessary steps to improvement. According to their last earnings conference call they have started creating clearer sidelines for customers, reduced their retail inventory by 6% quarter to quarter and are focused on building their new and improved online platform which should make shopping easier and faster for their customers. Their recently opened stores are also performing to a mid-single digit percent better than others and have achieved a better inventory reduction in these stores by 10%. BBBY also plans to launch 40 new lab stores. These stores will have a different presentation and will be used to test out various assortments and store operations.

BBBY’s best performer right now is decorative furnishing which has grown in the mid teen percentage range. Decorative furnishing is positioned in over 70 Bed Bath & Beyond stores and is expected to expand to 150 stores in 2019. The company plans to introduce new 6 in-house brands in 2019 and 2020 which should help them better separate themselves from their competition.

Investment Thesis

Currently the market views BBBY as a company struggling with its margins and revenue growth. As a result, it trades at a valuation much lower than its competition.

However, I believe in the long-term the stock is undervalued due to the following reasons:

1. Store closures

  • With closing underperforming stores Bed Bath & Beyond is well positioned to decrease its operating expenses and cost of goods sold. The company plans to close 40 stores with the majority being Bed Bath & Beyond and open 20 new Buy Buy Baby stores. With lowering their capex numbers, reducing inventory therefor freeing up more working capital in recent years and focusing on successful brands (Buy Buy Baby and the new decorative furnishing brands), BBBY will be able to attract more customers while lowering its costs.

2. Will slowing GDP growth affect retailers as much as we think?

  • With GDP growth directly reflecting consumer spending, I think the economic outlook of the US will directly reflect BBBY’s revenues and therefor share price. After growing by an estimated 3.1 percent in 2018, real GDP is projected to grow by 2.3 percent this year and will slowly flatten out in future years – reflecting the slower business growth and consumer spending. The unemployment rate is expected to continue declining this year, but it will start rising after reflecting the flattening of the GDP growth. At the same time stronger demand for goods and services is expected to push the rate of inflation up slightly above 2%. With slowing GDP growth I expect retailers to have a harder time in the coming years and with the upcoming store closures, renegotiating lease agreements and cost cuts I think BBBY is positioning itself well to handle a tougher economy.

3. The state of brick-and-mortar stores

*Picture taken from https://www.retaildive.com/news/why-most-shoppers-still-choose-brick-and-mortar-stores-over-e-commerce/436068/

Are brick-and-mortar stores really going away? Brick-and-mortar store closures were in record numbers in 2017. US closures neared 9,000 in 2017 and in 2018 more than 3,800 stores closed. These are some worrying numbers for BBBY. E-commerce has been growing, but the % of e-commerce as a total percentage of retail sales is too small of a fraction to make such a big difference, just 10% according to Statista expected to grow to 13% for 2021. Retail dive surveyed 1,425 US consumers and 62 percent of them chose in-store shopping over online because they want “to see, touch, feel and try out items”, 49% chose in-store buying, so they can take items home immediately and one in five consumers say the easy returns are the reason for shopping in stores rather than online. From all that research I would say that brick-and-mortar stores are evolving more than anything else. Focusing more on brands that sell and locations that work. Bed Bath & Beyond is already focused on evolving its stores. With initiating as many as 40 stores the company will be able to bring new experiences to customers, while being able to determine where these new experiences can efficiently and cost-effectively be rolled out to a larger number of stores.

4. Online presence

*Picture taken from https://fitsmallbusiness.com/death-of-brick-mortar-retail/

According to a recent research many consumers do research online before buying. More than 75% of in-store buyers report starting their search online. With a new and upcoming online platform Bed Bath & Beyond will offer consumers a more simplified user experience which in turn will bring a more positive online experience, boosting BBBYs online presence. While it will take some time to improve on the SEO of the new platform, this will be offset in the beginning by the increased session durations of users on the site.

Any of the above factors represent a significant difference from the current market view of the stock and could result in substantial upside.

Catalysts

Catalysts in the next 12-15 months include:

  • Cost cutting.
  • Introducing the new decorative furnishing brands.
  • Introducing the new web platform.

Catalyst #2 and #3 focus more on a shorter term valuation. Catalyst #2, introduction to the new decorative furnishing brands, may result in more aggressive marketing from BBBY, but ultimately will help them elevate their business. With buying products of small or private brands becoming more and more a growing social trend in the past years, introducing a new private brand like Bee and Willow BBBY positions itself well to attract more new customer and bring some old ones back.

Catalyst #3, the introduction to their new web platform, will result in longer session times and better experience for clients. With more and more people researching online before they buy, an improved usability will surely boost BBBY’s sales and online exposure. It will help the company stay relevant and increase brand awareness by communicating the company’s values more effectively. 93% of consumers consider visual appearance to be the key deciding factor in a purchasing decision.

Catalyst #1, focuses on a more long-term valuation. By continuing to close stores BBBY will be able to handle any slowing down of GDP growth with even being able to increase its profits. With focusing more on online presence, raising the free shipping threshold and optimizing the coupon strategy and SG&A expenses, BBBY slowly, but steadily is turning into a value stock. Although short term with increasing store membership operating margins have slowed down in the long term I expect an increase in customers and revenue.

WITH significant cost cuts and slow but steady market share growth, the implied share price is in the $20.86 - $25.88 range. This is the range if BBBY continues to close stores (an average of 7 per year), which will help them grow EBIT an average of 33% over a 5 year period with revenue growth at around 0.2% CAGR for the next 5 years. The model also factors in a slight increase in COGS around 1% on average per year for the next 5 years:

*My calculations, based on company filings.

Please keep in mind that BBBY’s revenue has grown at around 0.6% CAGR and COGS has grown around 2% CAGR for the last three years including TTM.

As a result, I believe that a +0.2% CAGR revenue growth over the next 5 years is reasonable, which combined with around 7 store closures per year will reverse BBBY’s share price.

All of the above represent catalysts that could reverse BBBY’s share price to our targeted range of around $20-26$ per share in the next 12-18 months; if they all come true and work as expected, the price may be even higher than that range, and if one or more is false, there is still potential upside in the stock, but it will be to the lower end of that range.

Valuation

*My calculations, based on company filings.

I have valued BBBY using public comps and the DCF analysis. The DCF analysis major driver is store closures while keeping Revenue growth +0.2% CAGR for the next 5 years.

To select comparable public companies I have used the following criteria: Retail companies with a similar product base and market cap: Target (TGT), At Home Group (HOME), Home Depot ( HD) and William-Sonoma (WSM). Within all the comparable companies BBBY is trading at the lowest valuation. I presume this is because of the last 3-4 years which Bed Bath & Beyond continued to open stores, but had no corresponding revenue growth and had a declining operating margin.

The discounted cash flow analysis uses the following “base case” assumptions:

Average store closures 7 per year for the next 5 years. Revenue growth +0.2% CAGR for the next 5 years. 8% discount rate (based on public comps and WACC), 3.0% terminal FCF growth rate, and standard discount periods. COGS growth of 1.9%. Primary EBIT increase comes from lowering SG&A expense.

Risks

The top risk factors include:

  • Slowing down store closures.
  • E-commerce growing much faster than expected.
  • The investment in new in-house brands not bringing in enough clients or revenue.

Key Takeaways

I think the market has a very skeptical mindset towards BBBY. An upside turn of the stock is highly possible after almost 4 years of price correction. With people still going into stores to tryout beds, kitchens, chairs etc. brick-and-mortar stores introducing new in-house brands more often and the industry finding new methods to evolve, I presume it is just a matter of time until the stock price of BBBY turns around.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BBBY over 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.