Editor’s note: This column is part of InvestorPlace.com’s Best Stocks for 2021 contest. Bret Kenwell’s pick for the contest is Bed Bath & Beyond (NASDAQ:BBBY).

I never thought I would be writing a “best stocks for 2021” article regarding Bed Bath & Beyond (NASDAQ:BBBY). But the turnaround work that management is undertaking could make BBBY stock a massive winner over the next 12 months.

In the first quarter of 2020, BBBY stock wasn’t even on my mind. No way can this company, poorly managed in years past, survive a pandemic.

But I was wrong. Not only has it survived, but Bed Bath & Beyond is thriving.

Last Quarter Showed the Turn

In fiscal Q2 (ending in August), the company reported earnings of 50 cents per share. Analysts had been expecting a loss of 29 cents per share. Additionally, revenue of $2.69 billion beat expectations by more than $72 million, even though sales declined 1.16% year over year.

 

But the progress goes beyond the top and bottom lines.

Comparable-store sales grew 6% vs. expectations of a 2% decline. Gross margins came in at 36.7%, up 1,000 basis points. And adjust gross margins came in at 35.6%, way ahead of estimates at 30.9%.

Best yet, Bed Bath & Beyond generated operating cash flow of more than $750 million. Free cash flow came in at more than $500 million, truly remarkable for a company with a market capitalization of $2.4 billion.

The company also “reduced its gross debt by ~$500M or 30% through a bond tender offer and repayment of a bank loan and further enhanced its liquidity position by ~$400M to ~$2.2B through strong cash generation and a new $850M secured asset-based lending facility.”

So in a nutshell we have:

• An earnings, revenue and comp-store sales beat;
• Better-than-expected and expanding margins;
• Robust operating and free cash flow; and
• Paying down debt and reducing leverage.

One quarter doesn’t make a trend. However, the company is clearly moving in the right direction. In the press release, CEO Mark Tritton said:

Our growth strategy is unlocking improved financial performance, and the marked improvement in our second quarter financial results reflects the potential of our digital-first, omni-always transformation and our efforts to build a modern, durable platform for success.

We’ve taken direct action to stabilize our business, including reducing our cost structure, enhancing our financial flexibility, and investing where it matters most to our customers.

A Deeper Look at BBBY Stock

Speaking of CEO Tritton, let’s dig into him a bit more. Tritton joined the company 13 months ago in November 2019. Before that he previously worked for Target (NYSE:TGT), Nordstrom (NYSE:JWN), Timberland and Nike (NYSE:NKE).

As he explained in the release, Tritton is pivoting the company to a digital-first, omni-channel retailer. He’s taking advantage of the store’s retail footprint while leveraging the digital space. BBBY stated:

“The Company continues to believe that its physical store channel is an asset for its transformation into a digital-first company, especially with new omni-fulfillment capabilities in Buy-Online-Pick-Up-In-Store, Curbside Pickup and Same Day Delivery.”

As such, digital sales grew 88% last quarter, while overall revenues appeared pressured because of a divestiture of One Kings Lane. Per the company:

“On a Preliminary Basis, Monthly Sales for September Show Positive Comparable Sales, with Similar Store and Digital Performance Trends as Second Quarter.”

The company’s decision to offload PersonalizationMall.com and Cost Plus World Market was also wise. Ultimately, Bed Bath & Beyond is shedding other assets and focusing on its core business. That will allow it to leverage its financials — and now it is.

On December 14, Bed Bath & Beyond approved $150 million for its accelerated share repurchase (ASR). That’s on top of the $225 million already in the ASR. That expands the company’s total share repurchase plan over the next three years from $675 million up to $825 million. Management plans to complete the purchases by February 27.

The company ended last quarter with $1.44 billion in cash and equivalents. A year ago, that figure stood at just $863 million. While cash is up, long-term debt and liabilities are down. Current liquidity is roughly double the company’s debt, assuring investors about BBBY’s cash situation.

Can We Get a Squeeze?

I want to focus on that buyback for a minute. Prior management made a huge mistake with massive buybacks when the company was eroding. Now that the company is rebuilding, buying back stock isn’t a bad idea per se.

However, the amount of stock management is talking about is significant. $375 million in an accelerated buyback is noteworthy — about 15% of the current market cap. If they expect to buy back more than $800 million worth of stock in three years, that would represent about one-third of the market cap.

Here’s where it gets interesting, though.

The short-interest of this stock is incredibly high, with 66.6 million shares sold short at the most recent reading. Unfortunately, short-interest data isn’t updated often. Fortunately, Nasdaq-listed stocks update twice a month, so we should get an update on BBBY stock in a few days (here is the schedule).

Most recently, 66.6 million shares were sold short, about half of the stock’s outstanding shares (of 126.01 million). If there is enough buying activity, it could spark a massive short squeeze in BBBY stock, as real buyers, the company’s buyback and short sellers buy-to-cover orders squeeze the stock higher.

Right now, the days-to-cover reading stands at more than 10 days.

While not robust, there has also been some insider buying. Again, it’s not massive, but it does speak to there being at least some confidence from those “in the know.” There are many reasons insiders sell, but only one reason they buy.

Bottom Line on Bed Bath & Beyond

Have a look at the weekly chart above, followed by the monthly chart below.

On the weekly chart, I see a robust move from the Q1 lows. BBBY stock powered through all its major moving averages and is digesting at the moment. In my eyes, this is simply a bull flag reset after a big rally.

Keep in mind shares are still up 28.5% this quarter, so some resting is required for the next leg up. Now traders will wait for some type of rotation higher, such as a rotation over the prior week’s high and the 10-week moving average.

On the monthly chart, you can see the recent consolidation this quarter.

The low in October, November and December is $17.95, $17.99 and $17.96, respectively. Clearly that’s the line in the sand. If BBBY stock closes below that, it could put the 10-month moving average in play and potentially trigger a gap-fill back into the $15 range.

What long-term traders want to see is Bed Bath & Beyond take out the October high at $26.16 and that volume weighted average price (VWAP) measure. Some will argue that this mark is not relevant on a long-term chart. That’s fine, but it did act as resistance two months ago.

It won’t be a straight line and perhaps BBBY stock never gets there, but clearing $26.16 could put the 100-month and 200-month moving averages in play. Currently near $40, that would mark an approximate move of 100% in the stock.

Earlier in the article, I mentioned that Bed Bath & Beyond had $506.5 million in free cash flow last quarter. The last time it topped $500 million was in CY Q1 2015, when BBBY stock was in the $60s. That doesn’t mean that’s where it’s going, only that if it can sustain the fundamental momentum it has right now, more upside is within reach.

Keep in mind that at the end of 2019, no one was expecting what we got in 2020. So cheers everyone, and good luck investing in 2021.

On the date of publication, Bret Kenwell held no position in BBBY, but is looking to initiate one before year end. 

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.