BED BATH & BEYOND 2020
Bed Bath and Beyond Inc. (BBBY) has been in operation for more than 40 years. Together with its subsidiaries, it sells a variety of home furnishing and domestics items, including bed linens, bathroom items, basic housewares, giftware, consumables and child and toddler merchandise. BBBY has tremendous reach with a distribution network that consist of over 1,100 retail stores across North America. It has also had some success growing its online retail space. Ultimately, BBBY competes to win consumers’ minds as the best place to shop within its respective markets. The basis of competition in the industry surrounds the variety and quality of products stocked, customer service, shopping convenience, uniqueness of product offerings, and prices.
Supported by a strong economy and a declining unemployment rate, the company achieved respectable top line and bottom line performance in FY2014, despite a slowdown in growth and softer management guidance.
Top line revenues grew by about 5.5% in 2014 and are expected to grow at a slightly slower pace of between 3-3.5% in 2015. Poor cost management resulted in a slight decline in earnings. An increase in SG&A from 62.6% to 64.6% of gross profits led to some margin compression, with operating margins falling to 14%, down from 15% in 2013. This remains well above 2009 recessionary lows of 9.4% and are now at levels typically achieved in normal economic conditions.
What is encouraging is the company’s ability to hold its returns, which reflects it strong cash position and aggressive repurchase activity. The company maintained over $1 billion in cash, repurchased over 10 million shares, and maintained a ROE of 25.9% and ROI of 25.5%. Since 2005, the company has generated an average ROE of 22% and ROA of 15%.
Rarely will an investor find a retailer with a business model that consistently works. BBBY’s model works. It is one of the most impressive retailers in operation stocking a huge, but well balanced, assortment of mid-to-upper end brand name specialty products and mid-to-low end lower cost products. BBBY’s strong merchandising and uncluttered and pleasant shopping experience combined with a greater product count per category stocked relative to most competitors will help the firm continue to hold its competitive position. While growth has slowed, penetration rates have likely not reached full saturation, particularly in Canada. The 2009 withdrawal of Linens ‘N Things and expansion push for buybuy BABY will provide an additional source of growth moving forward but does require some additional traction. Management’s commitment to maintaining EPS strength and minimizing balance sheet risk bodes well for investors, and is demonstrated through its share repurchases, minimal use of debt, and fully serviceable operating lease agreements.
BBBY’s slower than expected 2014 sales growth and earnings downtick have raised some concerns. One, it is believed that some consumers have found better shopping alternatives than BBBY and/or no longer consider the BBBY shopping experience to be unique. Two, it is believed that some consumers might now consider BBBY prices to be too high relative to competitors such that BBBY’s basis of differentiation is slipping. Three, it is believed that new and existing competitors have broadened their product lines and have imitated BBBY’s store concept, effectively stealing away consumers. As with all retailers, it is important that investors continually monitor BBBY’s competitive position.
Long-Term Rate of Return Analysis
Since 2005, BBBY has shown a 190% increase in earnings per share—never with a losing year, compounding at a rate of 13%. With EPS of $4.79 in 2014 and a market price of $61.33, it can be argued that BBBY is producing an initial rate of return of 8%. Since 2005, BBBY’s book value per share has grown by 116%—never having a declining year and growing at a compound rate of 9%. BBBY continues to hold a dividend payout rate of 0%. Historical data is shown in the figure below.
If it is assumed that BBBY’S EPS will grow at its historic rate, then EPS will be $16.25 in 10 years. Using econometric methods, a more conservative projection is that BBBY’s long term earnings will grow at an annual rate of only about 2.3%. This means that BBBY should have per share earnings of $6.03 in 2024. What will BBBY’s earnings growing at a rate of 2.3% be worth in 10 years?
The answer to this question will depend on what P/E multiple the market is using to value the stock in 2024. It is useful to look at the distributional properties of BBBY’s historical P/E multiple.
|P/E Historical Summary||P/E Expectations|
|Std. Dev.||3.33||P/E Normal||16.00|
|Mean Abs. Dev.||2.76|
If BBBY trades at Bear multiples, then the market price for the stock in 2024 will be $72.36. If BBBY trades at Bull multiples, then the market price will be $180.90. Based on historical data, in normal conditions BBBY trades at 16x earnings. The price of the stock would then be worth $96.48 in 2024. Assuming the firm's payout ratio rises to 20% in 2018, it would produce $7.40 in additional income over the forecast horizon. Added to the price of $96.48, the position would generate a total return of 69% and a compound annual rate of return of 5.4%.
If it is felt that the econometric based growth estimate is too low and an average estimate of the firm’s realized growth (13%) and econometric based estimate is more appropriate (7.65%), then the firm’s stock price in 2024 would be $128.18. Adding the dividend of $7.40, this would produce for investors a compound annual return of 8.3%.
The question that remains is: is a compound annual return of between 5.4% and 8.3% sufficient enough for investors to qualify for investment?