There have been two key points that have driven my bearishness toward brick-and-mortar retailers like Bed Bath & Beyond Inc. (NASDAQ:BBBY).
The first is that retailers are struggling when the economy is good. What, then, happens when that inevitably changes? The second is that performance among the group has been so poor of late that even flat same-store sales seem like a win. But zero same-store sales growth typically means that earnings will decline. And a stock with declining earnings generally shouldn’t trade for more than 10 times its earnings per share — unless an investor believes a turnaround is on the way.
And so as cheap as many retailers have looked — often trading at single-digit EPS multiples — they generally aren’t cheap enough if revenue is flat or declining. And no stock has better proven that argument than Bed Bath and Beyond stock. In fact, I made exactly those points about BBBY in arguing against the stock back in June, ahead of the company’s fiscal first-quarter earnings report.
Bed Bath and Beyond stock has fallen 40% since then. It’s an understatement at this point to call Bed Bath and Beyond in trouble. The declines aren’t new: BBBY stock now has fallen by 75% since early 2015 in an almost uninterrupted decline. A disastrous fiscal Q4 report earlier this month sent the stock to a 17-year low.
But this isn’t a buying opportunity. The two points that apply to retail, and to Bed Bath and Beyond, are just as salient now as they were last year. And they both suggest that the decline in BBBY stock isn’t over.
Bed Bath and Beyond in Trouble
Again, it’s important to remember that even flat comps lead to negative earnings. Indeed, that’s what has happened at Bed Bath and Beyond.
In fact, over the past three years, total revenue has actually risen by about 4%. And total same-store sales have fallen only about 1% after a 1.3% decline in fiscal 2017.
But net income has fallen by more than half. Gross margin has compressed 290 bps, thanks, in large part, to the impact from the lower same-store sales. SG&A spend has climbed 20%, representing 25.8% of revenue in FY14 and almost 30% of sales last year.
The moves don’t necessarily sound huge — but that’s the problem with the retail model. BBBY had operating margins of 13% in FY14; they were halved by FY17 due to the aforementioned issues.
But the problem for Bed Bath and Beyond is that the margins now are so thin that smaller moves have a big impact. A repeat of the last three years would leave the company unprofitable in terms of operating income. The margin for error is getting thinner and thinner — and Bed Bath & Beyond’s performance is getting worse and worse.
BBBY Stock Is Not Cheap Enough
BBBY stock does look cheap, at 7-8 times the company’s rough guidance for FY18 EPS in the “low-to-mid $2.00 range.” But that EPS has been halved in the last two years. Even a 7 multiple suggests that earnings have to stabilize at some point, if not immediately. Bed Bath & Beyond management itself said on the Q4 conference call that it expected EPS to decline in FY19, before growth returns in fiscal 2020.
Even if that is the case, BBBY stock isn’t particularly cheap. It still trades at something like 10x ~$1.75 in FY19 EPS. And that guidance requires that comps turn back positive — no sure bet — and that margins hold up.
A forward price-to-earning ratio of 10 sounds cheap in the context of the market, but it’s not particularly so in retail, particularly for a company like Bed Bath & Beyond that has a fair amount of debt. GameStop Corp. (NYSE:GME) (admittedly, a somewhat different story, given the pressure from digital downloads) trades at less than 5x forward EPS estimates. Williams-Sonoma, Inc. (NYSE:WSM) trades at 11x, with a better growth profile.
And with intense competition from Amazon.com, Inc. (NASDAQ:AMZN) and other online retailers, does anyone really believe that a return to growth is the most likely outcome? And to one of the original points here, what happens if the economy turns in the next two years?
Bottom Line on BBBY Stock
Bed Bath & Beyond is taking steps toward a turnaround, working on improving sourcing, which should help gross margin, and hoping digital sales can help on the top line. Will Healy argued this month that the company could take a page from Best Buy Co Inc (NYSE:BBY), which has executed one of the few successful turnarounds in the retail space.
But Best Buy already had invested in its e-commerce capabilities ahead of its turnaround. Its competition largely has fallen by the wayside (see the bankruptcies of Circuit City, hhgregg, and RadioShack). It largely has the electronics space to itself, giving it time to fend off the so-called “showroom effect“.
Bed Bath & Beyond has none of those benefits. Its competition is alive and well. Its online business is growing — but off a small base. And the pressures driving margins down aren’t going anywhere.
BBBY stock might look cheap. But it’s looked cheap for a couple of years now — and it keeps heading down.
As of this writing, Vince Martin has no positions in any securities mentioned.
