Bed Bath and Beyond’s Free Cash Flow Rise Will Ramp Up Shares

Bed Bath and Beyond (NASDAQ:BBBY) reported on Oct. 1 a massive growth in its profits and free cash flow for its fiscal second quarter ending Aug. 31. This growth will push Bed Bath and Beyond stock up over the next year.

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This is what is powering a huge new “accelerated” share buyback program that the company just announced on Oct. 28. I suspect that as a result, the stock is deeply undervalued.

A Blowout Quarter

On Oct. 1, management reported that for its fiscal quarter ending Aug. 31 comparable sales grew 6% year-over-year (YOY). But more importantly, its online digital sales grew 89%.

On top of that, adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), a form of cash flow, grew 36% YOY to $199 million.

To top things off, its free cash flow (FCF) for the quarter was an amazing $506.5 million. Keep in mind that this was higher than its Christmas quarter ended Feb. 28 when FCF was only $244.8 million.

In other words, during one of the normally slowest quarters of the year, Bed Bath and Beyond more than doubled its FCF over the Christmas related quarter.

That non-linear growth spike is not normal. The root cause is that people are now buying home-related goods online in an explosive manner. It’s a function of retail spending change, the lock-down restrictions, and new ways of shopping getting into customer’s behavior patterns.

The same sort of thing has occurred at Wayfair (NYSE:W), (NASDAQ:OSTK), and Amazon (NASDAQ:AMZN). They also reported blowout quarters. I have written articles about these companies as well.

Change Is in the Air

Several weeks after reporting these amazing quarterly results, Bed Bath and Beyond put on an interesting Investor Day presentation. One of the key takeaways is that the company is closing 200 of its 900 stores, in an effort to increase digital penetration.

Moreover, the company indicated it expects to see a $1 billion reduction in inventory and high inventory turns. Both of these will lead to an increase in FCF of between $500 million and $1 billion over the next three fiscal years, according to the presentation.

As a result, the company expects to reduce its gross debt-to-EBITDA credit ratio to 3.5 next year and to 3.0 times in the following year.

Buybacks Will Move Bed Bath and Beyond Stock

Moreover, as mentioned above, the company announced on Oct. 28, based on sales of non-core assets, it was going to repurchase $225 million of its shares. This “accelerated” share buyback program is set to be finalized before the end of the company’s fiscal year ending Feb. 28, 2021 (its FY 2020).

On top of that, the company plans to buy $150 million per year over the next three fiscal years ending Feb. 28, 2024. So the total buyback program will be $675 million over the next three and a half years.

Keep in mind that Bed Bath and Beyond stock has a market capitalization of just $2.46 billion. Therefore, the $225 million share buyback before the end of February 2021 represents 9.15% of its shares, assuming the stock does not move up. The total buyback represents 27.4% of the stock market value (again assuming no price rise).

But, of course, Bed Bath and Beyond stock is bound to move significantly higher. This is based on both the growth transformation and the lower supply of common stock shares outstanding from the buybacks.

What to Do With BBBY Shares

At this point, the stock has an implied FCF yield that is off the charts. For example, if it were to produce $506 million in FCF each quarter over the next year, that implies an FCF yield of 82.4% (i.e., $2.024 billion divided by $2.46 billion market cap).

A more normal FCF would be 10% at most. In other words, if this FCF continues apace, the stock is worth $20.24 billion, or 8.2 times the present price.

Let’s be realistic. It is highly likely that this was a one-off quarter. Nevertheless, it is possible that FCF could end being significantly positive over the next year.

Let’s be conservative and assume that Bed Bath and Beyond produces $750 million to $1 billion in FCF annually. Even with a 20% FCF yield, its market cap should be between $3.75 billion and $5 billion.

That represents a 52.4% to 103% gain over today’s price. In other words, Bed Bath and Beyond stock is worth $30 to $40 per share compared to its current around $20.

And this does not even take into account the effects of share buybacks, debt reduction, gains in FCF and analysts rebooting their analyses on the stock. All in all, Bed Bath and Beyond is significantly undervalued.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

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