The era of superstores is drawing to a close. There was a time when they were gobbling up market share, putting the little guys out of business. However, retail players are running out of gas, as Amazon (AMZN) are others have muscled them out of the way, thanks to lower operating overhead.
That’s one reason why Bed Bath and Beyond (BBBY) is struggling … badly. There’s another reason, though, which has to do with its entire business concept.
I’ve always thought of BBBY as the home accessories version of Whole Foods Market (WFM). It offers upscale versions of all the same things you can get at cheaper retailers. The people who shop at BBBY are the same who shop at Whole Foods and Nordstrom (JWN).
Except the BBBY demographic has figured out that they can get the same things for lower prices at regular retailers like Macy’s (M), just like the middle class has bailed on upscale grocery stores to shop at dollar stores.
Look at BBBY stock quarterly earnings and you’ll see why this has all come home to roost.
A Closer Look at BBBY Earnings
BBBY sales rose 3.1% to $2.74 billion, up from $2.66 billion last year, which isn’t terribly impressive, but nor is it awful. What matters, of course, is same-store sales. BBBY same-store sales rose 2.2% — again, not very impressive, although better than last year’s 0.4%. If we back out the 0.3% effect from currency exchange rates, it’s a marginally better 2.5%. Meh.
At first glance, we look to the flatlined earnings, which came in at 93 cents per share of BBBY stock. However, as I often counsel, you have to look past EPS and look to actual net income to see the effect of share repurchases.
That’s when you might cringe, and see the 15% decline in net income, from $187 million to $158 million. Ugh.
Not surprisingly, cash flow suffered at a result. Operating cash flow fell from $184 million to $154 million, and free cash flow fell to $86 million from $120 million.
Here’s even more to wince about. Net income fell $30 million because SG&A expense rose $40 million. At a time when sales are faltering, BBBY needs to get expenses under control and instead they got worse.
Then BBBY did something I hate. The company took on $1.5 billion in debt over the past year, generating an $18 million increase in interest expense. The debt is being used, of all things, to repurchase stock. I generally hate this move because it means, in this case, that BBBY is paying about 5% every single year in the hopes of increasing the company’s value by at least 5% every single year.
This strategy occurs when management has run out of ideas on how to grow organically. It purchases its own stock regardless of price, claiming it is undervalued, and that in turn pushes the price of the stock higher, which makes valuation all the more untenable.
Besides that $1.5 billion of debt that’s now on the balance sheet — the first time BBBY has drawn down debt in 20 years — it does hold about $791 million in cash and securities.
Bottom Line for BBBY Stock
As mentioned, valuation is just ridiculous. BBBY management says to expect flat to mid-single-digit EPS expansion this year. When factoring in the buybacks, however, net income is contracting. With the stock at $70, and goosed EPS alone at $5.25, you’d be paying 13x earnings for a no-growth BBBY stock that doesn’t even pay a dividend.
Sell now.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long AMZN. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
