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Bed Bath & Beyond Stock: Steer Clear

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About: Bed Bath & Beyond Inc. (BBBY), Includes: TGT
by: Adam Levine-Weinberg CFA
Adam Levine-Weinberg CFA
Long only, Deep Value, growth at reasonable price, long-term horizon
Summary

On Wednesday, Bed Bath & Beyond reported another quarter of falling sales and plunging profitability.

While Bed Bath & Beyond stock retreated sharply on Thursday, it remains far above its August 2019 low.

Investors may be too optimistic about the likelihood that new CEO Mark Tritton can drive a successful turnaround.

A $250 million-plus real estate sale-leaseback deal announced earlier this week isn't necessarily good news, either.

Bed Bath & Beyond (BBBY) has been struggling for years, as a perfect storm of changing consumer shopping habits, a lack of innovation, and a culture that prioritized penny-pinching finally caught up with the once-mighty home goods retailer.

Sales growth petered out several years ago and revenue has since started declining. Adjusted EPS peaked above $5 in fiscal 2014 and fiscal 2015 but has deteriorated rapidly since 2016. By fiscal 2018, adjusted EPS stood at just $2.05, and Bed Bath & Beyond is on track to post another sharp earnings decline for fiscal 2019.

As a result, Bed Bath & Beyond stock plunged from nearly $80 five years ago to less than $8 by August 2019. But the stock then rebounded sharply in late 2019, mainly due to optimism about the hiring of a new CEO: Target (TGT) veteran Mark Tritton. Bed Bath & Beyond shares more than doubled in the last few months of the year to end 2019 above $17.

Chart
Data by YCharts

Tritton is a talented executive with relevant experience in developing private brands. However, turning Bed Bath & Beyond around could prove to be an impossible task, making this a stock to avoid until/unless the company demonstrates meaningful progress.

Another earnings wipeout

Entering fiscal 2019, Bed Bath & Beyond's previous management team insisted that adjusted EPS would return to growth, rising to between $2.11 and $2.20. For 2020 and beyond, they had even grander ambitions of double-digit annual EPS growth.

As recently as early October, the company was sticking to a forecast for modest full-year EPS growth, even though sales fell 7% and adjusted EPS plunged nearly 40% in the first half of fiscal 2019. However, Bed Bath & Beyond released a dreadful Q3 earnings report on Wednesday and finally abandoned its fantasy of growing EPS this year.

Comparable store sales decreased 8.3% last quarter, while total sales declined 9%. Meanwhile, negative operating leverage along with continued pressure on merchandise margin caused further margin erosion. Bed Bath & Beyond reported an adjusted net loss of $0.38 per share for the quarter, compared to an adjusted profit of $0.02 per share a year earlier.

To be fair, the first full week of the holiday shopping season (beginning on the Sunday before Cyber Monday) has shifted from Q3 to Q4 in Bed Bath & Beyond's 2019 fiscal year. This hurt sales and earnings last quarter. The company said that comp sales fell just 3.6% adjusted for this calendar shift. Furthermore, comp sales rose 7.1% over the key five-day shopping period from Thanksgiving to Cyber Monday.

That said, Bed Bath & Beyond took a big special charge in Q2 related to markdowns needed to reduce inventory at an accelerated pace. In theory, those markdowns should have boosted traffic and sales last quarter. Furthermore, the sales jump over Thanksgiving weekend didn't create any lasting momentum. Later in the earnings release, Bed Bath & Beyond stated, "The Company expects its sales and profitability to remain pressured during the fiscal 2019 fourth quarter." It therefore withdrew its full-year forecast without providing new guidance.

The sale-leaseback deal isn't encouraging

Earlier this week (prior to the dreadful earnings report), Bed Bath & Beyond stock rallied on news that the company had netted more than $250 million from selling some of its real estate. (The assets sold included the corporate headquarters, a distribution center, and 12 stores.) This was about half of the company's owned real estate, according to The Wall Street Journal.

While $250 million is a substantial sum for a company that currently has a market cap below $2 billion, this isn't free money. Bed Bath & Beyond has signed long-term leases ranging from 12 to 18 years for all of the space it sold. The company revealed on Wednesday that these leases will increase its costs by $11 million annually before tax. (See below.)

A slide detailing Bed Bath & Beyond's real estate sale-leaseback(Source: Bed Bath & Beyond Q3 earnings presentation, slide 6)

The cash cost of this deal is presumably even higher, since some of the previous occupancy expense consisted of non-cash depreciation of the buildings.

Bed Bath & Beyond hasn't said much about what it will do with this cash. Investments in the business, share buybacks, and debt reduction are all on the table. However, while buybacks could potentially juice EPS in the short term, they would do nothing to halt the company's long-term margin erosion. Tritton wasn't hired to wind down the business. He is more likely to use the extra cash to fund turnaround investments. However, that means Bed Bath & Beyond is committing to extra rent costs in exchange for cash that will produce uncertain returns.

There's no easy fix

As I discussed briefly last month, while Tritton was very successful as chief merchant at Target, investors can't count on similar results at Bed Bath & Beyond.

I have no concerns about Tritton's ability to spearhead the development of new private brands that deliver a mixture of style and value. He is also likely to make positive steps towards refining the rest of Bed Bath & Beyond's merchandise assortment. However, merchandise changes alone won't fix what ails Bed Bath & Beyond. The real problem is stemming the long-term decline in store traffic.

That will be far more difficult. Target's household essentials and grocery businesses drive strong traffic to its stores. Once customers are there, Target can display new brands and styles created in-house. As long as the merchandise is compelling, strong sales will likely follow.

The exterior of a Target store(Target benefits from consistently strong store traffic. Image source: Target.)

By contrast, Bed Bath & Beyond doesn't benefit from these "frequency" categories, although it does sell some household essentials in stores that include Harmon/Face Values sections. It's becoming increasingly difficult to get customers to choose Bed Bath & Beyond to buy new bath towels or kitchen utensils when they can buy those items on one of their Target runs.

On the bright side, Bed Bath & Beyond could potentially pick up some sales from failing home decor purveyor Pier 1 Imports over the next few years. However, it seems equally likely that both home goods retailers will continue to lose sales to better-positioned rivals.

A turnaround story to avoid

While Bed Bath & Beyond stock plummeted 19% on Thursday, that pullback does not represent a buying opportunity. Adjusted EPS for the last four quarters has fallen to just $1.28. While the company has withdrawn its full-year guidance, its statement about sales and profit pressure continuing in Q4 suggests that another year-over-year decline is likely this quarter. In this context, the stock doesn't seem especially cheap based on its Thursday closing price of $13.45.

The best hope for a recovery is that improved operational performance could drive a margin rebound, boosting EPS. However, if sales continue to slide (as I expect), any margin gains from cost cuts or improved inventory management would probably prove temporary. Over the long term, it's virtually impossible for retailers with steadily declining sales to offset the impact of negative operating leverage. Thus, investors should stay away from Bed Bath & Beyond stock.

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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.