Anyone who has ever invested in the retail sector knows it is an up-and-down, volatile business.
These stocks can move 5-10% every month when monthly same store sales are released. Retail has low barriers to entry and few competitive protections, making competition intense. The history of retail investing is littered with one-time sector heavyweights that came crashing to the ground and, eventually, put under ground!
Don't believe me? Search for Montgomery Ward, Woolworth, Circuit City, CompUSA, Linens N' Things, Borders, KB Toys... the list goes on and on. Retail is a TOUGH business, and just as tough to invest in.
When you invest in retail value stocks, you want to look for two things. One, you want a best-in-category retailer with significant scale advantages (the only true competitive advantage). Two, you want to buy it at a healthy discount to a reasonable fair value calculation.
Best and Largest in the Home Furnishings Space
Bed Bath & Beyond operates 1,011 namesake "big box" home furnishings stores in the U.S., Puerto Rico, Canada, and Mexico, selling bed and bath accessories, kitchen items, and miscellaneous gift items. It also runs a few other smaller concepts, including 269 World Market/Cost Plus stores (a more eclectic take on home decor), 86 buybuyBABY locations (baby stuff), 76 Christmas Tree/andThat! stores (price conscious home decor), and 49 Harmon locations (discount health and beauty).
There's little question that BBBY is the top dog in home furnishing retail. Since Linens N' Things went defunct in 2008, it is the only stand-alone big box home items store, with 11% share in this massive $100 billion market.
The company also has a well-deserved reputation for being well-run. CEO Steven Temares has been with the company for over 20 years, and co-founders Warren Eisenberg and Leonard Feinstein are still active in operations. BBBY has impressive 5-year figures of 10% compound annual revenue growth, 20% annual EBIT growth, 20% average return on equity, and has reduced shares by an average of 4% annually since 2008.
Did I also mention that this is one of the few $14 billion dollar companies you'll find that has ZERO debt?
Best-in-category retailer? Check.
Clearly Below A Reasonable Fair Value Price
We like the company, but do we like the stock at its current price?
To answer this, we need to determine a few things. First, how much growth potential does BBBY have going forward?
Management feels there is a potential for about 1,300 U.S. Bed Bath and Beyond locations, and with already 1,000 built, big growth is not in the cards here. However, its other concepts, notably buybuyBABY, still have plenty of room to grow. Additionally, BBBY has delivered above average same store sales growth - over 5% per year in the past 5 years.
On the risk side, same store sales growth has slowed down recently due to more intense price competition and a still-evolving pattern of online buying from consumers. This will mute same store sales going forward and likely prevents any kind of meaningful margin expansion.
I believe BBBY can open 10-15 new Bed Bath stores, 5-10 World Market, and 10 new buybuyBABY stores annually over the next 5 years, or about 2% square footage growth. I also see same store sales averaging 2-3% growth, and share count declining about 3% annually. This gives me a near term growth expectation of 7% per year, with operating margin remaining steady at about 15%.
The second question is: what is the valuation potential?
Bed Bath's stock currently trades at an EBIT/EV earnings yield of 12.3%, meaningfully below its 5 year average of 10.5%. I see no reason to believe the market will not bid the stock back up to historical (and retail) norms.
Plugging these assumptions into a discounted free cash flow and valuation models, I get a melded target price of $78/share. That's about a 15% premium on the current stock price of $68 - not bad in today's fairly valued stock market.
Bed Bath and Beyond is a top-notch retail company in its space, and the stock is selling at a reasonable discount to my fair value calculation. It makes for a solid choice in a fairly valued market.