Bed Bath & Beyond Inc. (NASDAQ:BBBY) headed higher on Thursday after the company beat expectations for its fourth-quarter earnings. However, today’s rally in BBBY stock feels like a dead-cat bounce back to where shares traded just a week ago.
While the headline numbers beat, the trend is down, and Bed Bath’s current attractive multiple will go nowhere but up.
I think the right move is to fade the rally here.
What’s Wrong With Bed Bath?
The headline numbers: Bed Bath’s Q4 revenues climbed from $3.4 billion a year ago to $3.5 billion, matching estimates. Meanwhile, the bottom line shrunk from $1.91 per share in Q4 2015 to $1.84 per share — but that was still enough to beat expectations for $1.77 per share.
The market is focused on Bed Bath & Beyond’s top-line story, which is gaining momentum. Comparable-store sales were up 0.4% in the quarter, ending a multi-quarter streak of negative comps. Actual brick-and-mortar sales are still weak, but strength in the digital channel is finally outweighing store declines.
The positive comp trend from Q4 is expected to continue. Management guided for Bed Bath & Beyond to comp positive next year. Sales are expected to grow in the low- to mid-single-digit range.
For a depressed retailer like BBBY, that’s great, and the stock is responding positively. But the market is missing the fact that the resurgent top-line story is being fueled by high spend.
Digital sales are soaring. Some of that growth, though, is a result of BBBY sweetening the pie for consumers on the shipping front. Competing with Amazon.com, Inc. (NASDAQ:AMZN) and Wal-Mart Stores Inc (NYSE:WMT) on free shipping perks is tough to do, but BBBY has tried its best. This is driving digital sales growth, but it’s also forcing Bed Bath & Beyond to absorb higher DTC shipping expenses. That is weighing on gross margins, which compressed 600 basis points in Q4 and are expected to continue to deleverage next year.
Bed Bath & Beyond is also spending more on advertising to drive sales growth. Meanwhile, wages are rising. Together, advertising ramp and wage hikes are driving the SG&A rate significantly higher. BBBY management expects this SG&A deleveraging to continue next year. What was a 26.5% SG&A rate in 2015 is moving ever closer to 30%.
All together, margins are compressing at a rapid rate. Although sales were up 3.4% in the quarter, diluted EPS was down 3.7%. A lot of that was actually driven by aggressive share buybacks. Excluding those buybacks, net income fell 11.5% year-over-year.
With BBBY, then, investors are looking at this huge disconnect between 3.4% sales growth and an 11.5% decline in net income.
This disconnect will only widen next year. Sales are projected to be up at a similar rate, and EPS is projected to be down as much as 10%.
Bottom Line on BBBY Stock
As an investor, though, I always look at the value. Bed Bath stock trades at 8.5 times trailing earnings, which is cheap at first glance. But that $4.58 in trailing-12-month EPS is expected to compress by as much as 10% next year.
Say that happens, and earnings come in next year around $4.10. If BBBY stock stays sideways for 12 months at $39, the trailing price-to-earnings multiple would be 9.5. It’s not bad, but it’s not grand — especially considering the company’s bottom line is contracting.
I don’t see Bed Bath turning things around. Shipping perks and higher ad spend are driving sales growth. Management will continue to have to absorb higher costs in those areas to maintain a steady top line.
At the end of the day, revenues will grow slowly and margins will compress rapidly. That isn’t a good combo.
I say fade the rally, and look for better value elsewhere.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
