Investors in retailer Bed Bath & Beyond (NASDAQ:BBBY) have been waiting for years for any kind of good news. Bed Bath & Beyond stock has collapsed in recent years. BBBY stock touched a 20-year low in December, at which point it had lost more than 85% of its value in four years.
BBBY now has rallied 64% from those lows. A big chunk of the gains came on Tuesday, when the stock rose 22% thanks to news of an activist effort at the company. Funds Legion Partners Holdings, Macellum Advisors, and Ancora Advisors have teamed up with a plan to replace the entire 12-person BBBY board of directors — as well as CEO Steven Temares.
Given the huge amount of value destroyed here, the activists have a strong case. And the huge spike in Bed Bath & Beyond stock suggests that investors believe the proxy fight will succeed. Even if it does, however, there’s a key question: is it too late to save Bed Bath & Beyond?
Why Activists Targeted Bed Bath & Beyond Stock
In their letter nominating 16 potential new directors, the BBBY activists make a compelling case. Simply put, Bed Bath & Beyond looks like a mess. Under Temares — who will celebrate his 16th anniversary as CEO next week — BBBY stock has declined some 58%.
The performance has been even worse of late with BBBY stock reflecting the deterioration in the business. In the last five years, gross margins have compressed from 39% to 34%. SG&A spend — at a time when most brick-and-mortar retailers are managing costs carefully, if not outright cutting expenses — has risen 27%. As a result, operating margins have collapsed from 14% to just 4%. Bed Bath & Beyond’s own guidance suggests FY18 (ending February 2019) EPS of just $2, less than half the $4.58 achieved just two years ago.
Specialty retailers admittedly are facing a tougher path at the moment. Home-focused sellers like The Container Store (NYSE:TCS), Kirkland’s (NASDAQ:KIRK) and Pier 1 Imports (NYSE:PIR) have struggled in recent years. But the investor group details the seemingly incoherent strategy at work at Bed, Bath and Beyond specifically, as BBBY continues to buy smaller companies (7 acquisitions in 7 years) with little success, while lurching from plan to plan in an effort to reverse declining same-store sales trends.
Despite those repeated failures, board and management compensation remain excessive. And the board has authorized a stunning $8 billion in share repurchases since 2011 — at an average price of $59. BBBY now has a market capitalization of just $2.4 billion — and trades at $17.
Why the Activists Can Win the Fight — and Save BBBY Stock
It would appear the activists have a strong likelihood of success. They’re showing how strong their beliefs are by looking to clean house — rather than just add a director or two to “get a voice” in the boardroom. Management and the board combined own just 5.5% of the company, according to last year’s proxy statement. Independent shareholders will decide this battle — and it’s hard to imagine too many of those shareholders favoring the incumbent management that sent the stock to a two-decade low.
Should the activists win, there’s a path toward improvement. For one, new management will have time. Bed Bath & Beyond has no debt due before 2024. That year, a $300 million bond needs to be repaid, but BBBY closed the third quarter with nearly $1 billion in cash. The next maturity is not until 2034, with most of the debt due ten years after that. The odds of bankruptcy seem remote.
The other fundamental reason for optimism is the current 4% operating margins. It simply doesn’t take that much in the way of improvement to materially boost earnings. The activists pledge to cut costs, and even a 4% reduction in SG&A would save about 1% of revenue, moving earnings higher by 25%.
Add in a potential reversal of the seven-quarter streak of declining same-store sales, and profits can grow sharply, and quickly. The investor group targeted EPS above $5 “over the next few years,” driven largely by margins that should double, or come close.
Assign even a conservative EPS multiple, and BBBY stock triples from current levels. Faster-than-expected growth and/or proceeds from selling (or shutting down) the smaller acquired businesses could drive even more upside.
The Risks
The key question here is just how much damage has been done and how long it will take to fix. BBBY has hemorrhaged market share in recent years to off-price retailers like TJX Companies (NYSE:TJX) and Ross Stores (NASDAQ:ROST), as well as online rivals including Amazon.com (NASDAQ:AMZN). Bed Bath & Beyond stores, as even the activists point out, feel like a jumbled mess. Those will require years of improvement and millions of dollars in capital spend to fix.
While the balance sheet seems reasonably clean, BBBY management has committed to some $3 billion in operating leases as of the end of last fiscal year. Those leases could slow any plan to shrink the company’s brick-and-mortar footprint or cost millions in termination fees.
Broadly put, even new management won’t be able to turn BBBY around in a matter of months. And while those improvements are being put in, sales may further decline and earnings may see more pressure. Even the big plans may not work out: Tuesday Morning (NASDAQ:TUES) stock soared earlier this decade on optimism toward an activist-led turnaround. That stock hit a post-crisis low in December.
Meanwhile, the key pressures on retail will persist. As I noted last year in warning investors away from BBBY, there are two points to remember about the industry as a whole. The first is that results should be much better right now given a strong economy. If same-store sales are falling now, what happens when a recession inevitably hits?
And the second is that even flat or +1% comps still generally suggest declining earnings, as inflation drives rent and labor costs higher. That’s doubly true as online sales grow — which generally are dilutive to margins.
In that context, Bed Bath & Beyond has a long way to go simply to stabilize profits. And new management will have its work cut out for it. There’s reason for hope — but plenty of reasons for caution, too.
As of this writing, Vince Martin has no positions in any securities mentioned.
