In a Million Dollar Nutshell ? Bad Business at a Good Price ?
Most investors will say management isn’t good enough, there are no competitive advantages, and there’s too many question marks over their retail prospects in the future to make this anything less than a very, very risky long-term hold. However, everything has a price. The bull case for Bed Bath is event-driven, a bet on surviving one of the worst cases of retail disease since Sears. The Bed Bath issues and the Bed Bath stock pose a new question for the investor, a far more important question; how low do you go? How deep do you dustbin dive for a value investing opportunity?
This Free Bed Bath and Beyond Primer Makes Sense Out of The Retailer!Disclaimer: I do not own Bed, Bath and Beyond (BBBY) at the time of writing. Disclaimer: chrismorrissey.money does not provide financial advice. All content is purely informational. Consult independent advice.
Bed Bath and Beyond is an American brick and mortar retailer struggling to cope with the digital age. In late 2017, the stock cost us $21 per share and a loud minority of investors shouted “oversold!”, “undervalued!”. Now, those same investors are staring at a $13 stock price. Blood Bath and Beyond! What was the investment thesis? Does it still apply? Was it a trap? Is it still a trap? Or, are we looking at a Graham net-net stock? One of the best and rarest opportunities in modern investing. Let’s find out!
How Bed Bath Makes Money ?
It sells beds and baths as a home furnishings retailer, brick and mortar style . By the time they were public in 92′ they were already a hot growth company running superstores, reaching revenue of a billion dollars in the year 2000. Three years later they doubled that and after the financial crisis they went on an acquisition spree, buying Harman, Buy Buy Baby, World Cost Plus, and Christmas Tree Shops. This spending spree has worked against them as they years have rolled on, something we’ll discuss later.
By 2015, things had started to unravel. Retail stores lagged behind their online counterparts, posting lacklustre numbers. Retailers struggled across the land as a shifting, if not dying, retail reality gripped Bed Bath , and gripped investors. Ouch!
Bed Bath Have Coupon’ed Themselves to Death ☠Coupons are typical in retail, a useful promotional tool to incentivise sales and get customers to come back. Bed Bath’s competitors use them, too. There are Williams-Sonoma coupons, Container Store coupons, Target coupons, and even Amazon coupons! But there’s something amiss about a Bed Bath and Beyond coupon…
And it’s all psychological.
Bed Bath is known for spoiling its customers with never expiring, 20% off coupons . These are discounts that are loved, and they’ve become a big reason why people shop at Bed Bath and Beyond. They expect the coupon! The problem has become that now, if a shopper doesn’t have a coupon, they decide not to shop at Bed Bath altogether.
In terms of margins, they bleed 20% every time a coupon barcode is scanned . Owing to how Bed Bath and Beyond rely on promotions and discounts in order to help stimulate sales and footfall, in terms of revenue, it’s questionable how much top line they could generate without the help of these famous coupons. This is a systemic issue and a real catch 22 for management. Of course, there are other factors at play in Bed Bath’s financial squeeze, but for now, let’s focus on what kind of revenue they could realistically earn on the merit of their own back.
The Numbers Tell a Sorry Story ?
Bed Bath’s primary job is to run successful stores. They may be omnichannel, but controlling over a thousand physical stores is a huge brick and mortar commitment to being at least competent at running a retail business. We’re buying a stock which means we’re buying a business, and the management comes with that. We should care if management knows what they’re doing running a business we own.
The Store Concept Isn’t Working
Year-to-year same store sales have declined 1.3% since 2015. That means the Bed Bath and Beyond store concept isn’t working (at least when put side by side with alternatives like e-commerce for example).
Let’s try taking those sales figures and comparing them to inventory levels in terms of growth rates. Inventory means all the stock you hold in your business, and the fact that inventory growth rates have exceeded revenue growth rates for Bed Bath, implies that there’s excess stock it’s struggling to sell . Are we really surprised? The company is trying to sell all of that stock off at a very low price point so that it can sell.
On to the next measure, cost of goods sold divided by average inventory . In other words, a low ratio here implies that Bed Bath and Beyond are facing poor sales and therefore excess inventory . This basically confirms our previous finding.
So, you’re probably wondering why on Earth I’m showing you this miserable business? Great businesses don’t always make great stocks, and bad businesses don’t always make bad stocks . Some investors will be tolerant of a bad business if it’s accompanied by an exceptional price.
The Buck Stops at The Top ?
Management is accountable for this mess. Management have done very little over the past few years to relieve fears about the retailers future, and they’ve well and truly botched the IT project that was supposed to bridge them over to e-commerce . When retailers embark on big IT projects, it’s usually slow with a disappointing end-product. Management are also responsible for the store concept failing, and they fluffed up their acquisitions in early years because by increasing the numbers of stores they had, they made themselves a bigger target for Amazon. Slow clap. ?
The former CEO, ousted by activists, was apparently excessively overpaid . He dominated management and consequently management’s communication style. This could be a clue as to why the coupon-ing situation got so bad and why there are so few investor relations events.
You can’t blame consumers for taking advantage of the coupons, or even for showrooming, which is prevalent in the home furnishings industry. Showrooming is when you walk into a store, choose your product, test it out, have a go, and then going on the web afterwards to find the cheapest price .
What about Amazon? Their entrance to the home furnishings industry has disrupted it hugely. It can deliver a bed in 1 week as opposed to the industry average of 6 weeks, and it’s also the biggest force for fear when it comes to the future of high street retailers in general.
But Don’t Count Them Out Yet ✊
Rivalry has always been building in the home furnishings industry with the market being fragmented and players selling many of the same products as each other. However, there can be no denying that Bed Bath and Beyond occupy a very powerful position in that brick and mortar crowd. The company’s economies of scale mean it can utilise buying power to source goods at cheaper prices than smaller players.
There’s also a reputation at Bed Bath for having the lowest price offering. That’s proven and secure . What’s more is that occupancy cost opportunities are starting to emerge in the industry as landlords see retailers move out, and encounter a newfound pressure to fill space. So, there’s hope for Bed Bath! The company is renegotiating leases to try for these more favourable agreements, led by activist investors who have replaced to the CEO to try and fix the issues themselves. If better lease agreements can’t be found, stores will close.
It could also turn to proprietary products in order to boost margins. This means Bed Bath’s own-brand products. It’s pursuing this and doing so does not negatively impact gross margins.
The Fortune Flipping 2 Year Project ?
The transition to online is obviously also in full swing with 70% of the company’s capital expenditures invested in new e-commerce . Obviously, the more online sales Bed Bath can make, the less foot traffic it will see in its stores. Same store sales figures will suffer at least partly, leaving you wondering if it’s worth having those stores at all! The company will also have to front shipping costs on online orders which will cut into margins more permanently.
A fully-fledged online storefront is supposed to be return Bed Bath to its old glory days. Until then, earnings for shareholders will be fairly muted . Understand this as you forecast cash flows.
If Bed Bath and Beyond can’t see results from these projects at current consumer confidence levels, the highest since 2004, the market will fear for them in a recession.
A Big Return Offered For The High Risk ?
For all the problems we’ve diagnosed at Bed Bath and Beyond, can we find any value in this business? Well, because of how ruthlessly investors have sold it off, perhaps from a basic financial standpoint we can. Management have most recently estimated a total of $2 EPS by year end, so if we assume they maintain the same ratio between the money the firm makes, and the money it currently pays out in maintenance CapEx, then you’re theoretically taking home $1 in free cash flow (money you actually get) from your Bed Bath and Beyond investment for every $2.40 you invest . However, as the company has a return on invested capital below its cost of capital, the stock chart is rightly getting destroyed.
Despite return on invested capital falling, other numbers are still competitive with rivals. The company intends to pay off its short term debt without any problems, but when it comes to long term debt, unfortunately that’s been neglected in recent years. Instead they’ve repurchased shares .
Repurchasing shares makes the a single slice of the pie more valuable in its own right because each slice gets bigger. It’s a positive thing, but I think there’s a lot of investors who would just like to see the fundamental balance sheet be strengthened and for that debt to be paid down.
Fundamental ratios are fundamental, they’re not everything! You can sometimes find companies that are deeply flawed and would make sour investments but they’re wrapped in attractive ratios like low prices to book and low P/Es. The most telling factors for Bed Bath lie outside of this fundamental analysis.
Close to Net-Net ?From a purely numbers-based analysis, Bed Bath sounds like a pretty good deal . So in spite of the world seemingly falling apart around it, investors may indeed have overdone the sell off. However, that would be to ignore the context of the predicament this business is really in. It’s up to you to make the final call!