When it comes to being a deep-value investor, one has to be able to distinguish between good businesses whose stocks have been sold off unreasonably and stocks whose companies are value traps. That is particularly true when it comes to retail stocks. Once retail chains pass their mega-growth phase, their stocks decline significantly — and for good reason.
Such is the case with Bed, Bath and Beyond Inc. (NASDAQ:BBBY). BBBY stock was terrific many years ago, as Bed, Bath and Beyond became a de facto superstore for all things home related. I was always rather surprised that the company did so well, because there were very few things you could buy at a Bed Bath & Beyond that you couldn’t get a regular department store like Macy’s Inc. (NYSE:M).
Bed, Bath and Beyond: Then and Now
But BBBY marketing was good. It sent out weekly coupons, the stores were always fabulously organized and had pretty much anything you might need.
The other trick why BBBY stock did so well for many years was that it priced its products at price points that were much higher than your average department store. It actually ran counter to the idea of the category-killing superstore, like Home Depot Inc. (NYSE:HD) which tried to put everyone else out of business by slashing prices.
Then the internet came along, competition increased, and Amazon.com Inc. (NASDAQ:AMZN) moved into the space. One could see things starting to get tight for BBBY stock four years ago.
The Beginning of the End
BBBY stock gross margins were 40.5%, operating margins were 16.5% and net margins were 10.5%. Now, four years later, gross margins are 36%, operating margins are 9% and net margins are 5.5%. It’s tough to run a business when your profit margins have basically been cut in half.
As I frequently discuss, I am always looking at comparable store sales to give an indication as to the health of the company. Comps for the fourth quarter were -0.6% and were negative by 1.3% for the year. Total sales for the quarter were up about 5%, and up only about 1.1% for the year. Unfortunately cost of sales increased significantly and, thus, we see a gross profit decline in both the quarter and the year.
SG&A expenses also increased significantly, up almost 9% for the quarter and 6.5% for the year. By the time the financial statement gets down to the operating profit line, the number has declined to $761 million from the year, down from $1.13 billion, a decline of almost 33%.
Bottom Line on BBBY Stock
Mind you, Bed, Bath and Beyond stock did have net income of $435 million, even though that was down from $685 million. Unfortunately, but to nobody’s surprise, management guided next year’s earnings down from $2.70 per share to $2.36 per share. Even at a price-to-earnings ratio of 7.5, BBBY stock is not at all attractive to me given the trajectory of revenues hasn’t changed.
It has very solid free cash flow, at $670 million. It has cash and investments of $750 million, and a manageable debt load. So, BBBY stock doesn’t have any kind of growth catalyst, but it’s not exactly going to run out of money either. It is very much in danger of becoming what I call a “walking dead” stock. Nothing exists to catalyze growth and operations are still strong enough to keep the company well-capitalized.
To me, this means the only way you can make money on BBBY stock is if either management suddenly has some incredible new vision for the company, which I doubt is going to happen, or you simply buy the stock and repeatedly sell covered calls against it, or sell naked puts against the stock repeatedly to generate income.
These types of option strategies are things to consider in terms of generating additional income. If you’d like to know more about them, consider subscribing to my investment advisory newsletter, The Liberty Portfolio.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].