Summary
- Bed Bath & Beyond troubles are mostly self-inflicted – resulting from flawed strategy and poor execution.
- The company’s turnaround is an uphill one doable with the hiring of Mark Tritton as CEO.
- The market is discounting the possibility of the company’s demise, although a strong financial position and cash flow generation provide sufficient cushion.
- Several potential catalysts could drive BBBY’s share price significantly higher from current levels.
Investment Overview
Bed Bath & Beyond (BBBY) is a company in the midst of transformation. It plans to close its traditional stores and replace these stores with ones that are lean and visually-appealing. If successful, this plan will improve cost structure and efficiency, leading to higher free cash flows that could be used to invest in retail channels and return cash to shareholders.
The current share price reflects market pessimism with expectations that the company will go bust. With comfortable cash reserves and continued turnaround efforts, accumulating BBBY shares at these levels offers a significant upside opportunity with limited downside.
Bed Bath & Beyond Woes Are Self-Inflicted…
Despite the narrative of an apocalyptic scenario in the retail industry, the furnishing segment is bucking the trend. While there are obvious headwinds, the US home furnishing markets appear fine and will likely remain so in the foreseeable future – with expectations that sales value will reach $79.4 billion by 2024, or CAGR of 6.4%.
For an iconic brand like Bed Bath & Beyond in the home furnishing segment, it is surprising to see market share erosion, impacting its operating margins and net profit figures. While the company managed to report relatively stable sales from $11.9 billion in 2014 to $12.03 billion in 2018, operating profit margins pressures (from 13.1% to 3.5%) have impacted its (adjusted) net profits, dwindling from $957 million in 2015 to $275 million in 2019.
The factors that have driven in the company’s underperformance are as follows:
- BBBY’s chains have fallen behind other retailers who have expanded their home goods presence with a new line-up of direct to consumer online brands. Big box retailers like Walmart (NYSE:WMT) and Target (NYSE:TGT) have moved into home furnishing private label brands, while Wayfair (NYSE:W) has spent massive advertising to strengthen its brand equity.
- The company’s pricing strategy is perplexing. Despite the reduction in lower prices, BBBY is still more expensive than Amazon (NASDAQ:AMZN) on similar items.
- Its outdated store design is an unpleasant sight to a discriminating shopper. In a Business Insider article, the company still employs the strategy of cramming as much product as possible – leaving shopping hard and turning off most consumers. While the company’s main advantage in the past was its vast choices of home furnishings, this was chipped away by the ease of ordering these products online from Amazon and Wayfair.
- Activist hedge funds accused the founding family of channeling the company’s resources to enrich themselves. These hedge funds highlighted the company’s questionable acquisitions of buybuy BABY ($67 million) and Chef Central ($1 million) and excessive executive compensation.
…But A Turnaround is Plausible
It is easy to dismiss that the turnaround efforts will be a dismal failure with the recent 2Q 2019 financial results. 2Q 2019 net revenues reached $2.7 billion, a 7.3% year-on-year decline – driven by the continued decline in comps, resulting in earlier decision to limit coupon usage, eliminate product SKUs and limit order quantities. Gross margins have also declined from 34.3% in 2018 to 30.5% in 2019, implying that the company is still struggling to find the right pricing strategy and balance between sales and margins. On an adjusted basis (ex-severance costs and inventory write-down), diluted earnings per share are at $0.34, a decline of 10.5% from the prior year.
