It’s a major retail brand, but its share price has had dramatic ups and downs over the past few years. Lately, though, the direction of Bed Bath & Beyond Inc. (BBBY, Financial) has been mostly down. That makes for an interesting Peter Lynch chart:
As the chart makes clear, share prices historically stayed reasonably near the earnings line until the latest plunge. By way of background, a Peter Lynch chart (named after the legendary mutual fund manager) shows a price chart on the green line and a 15 times earnings line in blue. With some conditions, Lynch liked to buy when the green line was below the blue line (undervalued) and sell when the green line was above the blue line (overvalued).
Is this gap between green and blue a clue that value investors should study?
For background on the company, see my article "Bed Bath & Beyond: Undervalued During This Dip," but keep in mind this article was written almost 2½ years ago. Since that article was written, the share price climbed to nearly $80, from about $60 at the time, and then subsequently fell back to the low $40s.
The pros
Valuation: Many, if not most, analysts and observers consider the company undervalued. That’s underlined with a check of the valuations-at-a-glance box at GuruFocus:
One of those valuations, the Discounted Cash Flow Fair Value Calculator, shows a 52% margin of safety:
In a Dec. 9, 2016 article, Benjamin Clark of ModernGraham wrote, “Bed Bath & Beyond Inc. qualifies for both the Defensive Investor and the Enterprising Investor.” And “the valuation model returns an estimate of intrinsic value above the price.”
Among the analysts followed by NASDAQ.com, no one is recommending Bed Bath & Beyond as a buy, but their 12-month Consensus Price Target is $43, slightly above the $40.58 close on Jan. 11.
Consistently growing earnings: The company earns a 5-Star rating (out of 5) for predictability, for consistently increasing its earnings over five years.
Bed Bath & Beyond has helped itself get that rating by repurchasing shares, a good strategic move when a company’s shares are undervalued.
Good allocation of capital: Can a company take the capital it receives from equity and debt and use it productively? Can it generate more than a dollar for every dollar it takes in?
Bed Bath & Beyond meets that test with a WACC (weighted average cost of capital) at 7.97% and ROIC (return on invested capital) of 21.84%.
Rewarding shareholders: In addition to buying back shares, the company has also started paying a dividend. Currently, the yield works out to 0.94% so it’s unlikely to have income investors shouting “Buy.” Still, Daniel Schonberger notes, “as the payout ratio is currently only about 10%, we can expect the dividend to be raised in the years to come. A payout ratio of about 30% would lead to a dividend of $1.50 and a current dividend yield of 3.75% – a realistic scenario.”
GuruFocus reports the three-year average share buyback ratio is 11.70% and shows it outperforming its sectoral peers: “[Bed Bath & Beyond]'s three-year average buyback ratio is ranked higher than 98% of the 484 companies in the Global Specialty Retail industry. (Industry Median: -0.50 vs. BBBY: 11.70)”
Online initiatives: Bed Bath & Beyond is not waiting and hoping. In recent years it has made several purchases that will allow it to compete online.
As Kenra Investors puts it, “The acquisition of One Kings Lane and personalizationmall.com has accelerated the growth in the online channel, which I estimated to account for more than $1 billion in sales before the acquisitions and now probably in the $1.2 billion to $1.3 billion range.”
Like Walmart (WMT, Financial), Bed Bath & Beyond may be able to leverage its existing network of stores to enhance its online appeal. Walmart uses its local stores as delivery points, eliminating the need to develop a distribution system. Unlike Amazon.com (AMZN, Financial), Walmart does not have to research delivery by drones; it already has a well-developed channel in place.
Cons
Structural changes in the retail industry: It’s no secret that much of retail suffers from the Amazon effect, bleeding market share to the online giant and its peers. Arguably, though, it’s not just prices and distribution; it’s a big cultural shift, somewhat generational perhaps, that sees many consumers shopping with their fingers rather than their feet. In a GuruFocus article, Rupert Hargeaves writes, “By taking an objective view and looking at the U.S. retail sector without any position, it is clear that the industry is suffering from some serious problems, problems that won’t be cured just by shutting shops and moving online.”
Which raises the question: Can Bed Bath & Beyond grow the new online businesses fast enough to compensate for the declines in bricks and mortar? There is, of course, no clear answer to that question, adding to the uncertainty.
Declining margins: GuruFocus reports, “Bed Bath & Beyond's five-year average operating margin growth rate was -5.30% per year.” That’s negative 5.3% per year. Incidentally, while that’s not good, GuruFocus also notes that its margins are higher than 80% of the 937 Companies in the Global Specialty Retail industry.
In an article titled "Stick A Fork In Bed Bath & Beyond," a pessimistic commentator using the nom de plume Stock Exchange said the company's “operating income margin declined to 7% from 10% in the year earlier period. Falling operating income margins amplify the pain of flat to declining top-line growth.”
Now carrying long-term debt: Although there is no indication that Bed Bath & Beyond’s debt is a problem, the mere existence of it will turn away some investors. Many value investors, the type of investors needed when the price swoons, will simply screen away or ignore the company.
As of Nov. 30, 2016, total debt stood at $9.92 per share.
External challenges: Commentator Stock Exchange also argues that the company’s fortunes are tied to those of the housing industry, which could pose a problem. “With interest rates at record low levels, the environment has been conducive for housing and home furnishing stores like [Bed Bath & Beyond]. The Fed has turned hawkish and is expected to raise rates a few more times in 2017. Rising rates could eventually slow home sales and home furnishings. If [Bed Bath & Beyond]'s sales have stagnated when rates were low, then what will happen in a rising rate environment?”
Also potentially lurking in the future are import tariffs. If enacted on products or supplies used by the company, prices might need to go up. This, in turn, would further reduce margins if Bed Bath & Beyond is unable to pass along all of the increases (again, if tariffs are imposed).
Greater dependence on technology: As Bed Bath & Beyond shifts its merchandising and marketing online, it will rely more heavily on technology. While the company will gain some expertise from the people and systems it acquires, it is not at its core a technology company. Keeping up with the Amazons and Wayfairs (W, Financial) will require changes all the way from the boardroom to the shipping desk. In its latest 10-K, the company said that “rapidly evolving technologies are altering the manner in which the company and its competitors communicate and transact with customers.”
Then, of course, there are the usual warnings about technology: disruptions, whether man-made or acts of God, theft of data and regulatory demands. It also notes in its 10-K that it depends heavily on technology to process transactions, manage inventory replenishment, summarize results and control distribution of products.
Summing up
Five reasons to be bullish and five reasons to be bearish about Bed Bath & Beyond. More arguments could be added on either side of the buy-sell equation, but these give us a taste of an investor’s quandry.
The analysis began by noting a sizable gap on a Peter Lynch chart, showing how price has dropped far below the 15 times earnings line. But is a price-earnings (P/E) ratio of 15 the old normal? Is there any likelihood, in the next few years, that the P/E will get back to the midteens? Probably the strongest argument on either side is the company’s history of consistently generating earnings, its 5-Star predictability.
Despite the predictability and current valuation, this is not a stock for a strict value investor. Not only does the company have debt, but no one knows if the price has bottomed out. Could it be a value trap?
For investors with broader constraints, it may help to look at simple moving averages (SMAs). This is a GuruFocus 10-year price chart, with the 200-day (SMA) in red:
A common strategy would be to buy when the share price rises above the 200-day SMA, and sell when the opposite happens, when the share price crosses below the 200-day SMA. Prudent investors, though, would want to use a trailing stop, say 7% to 10%, rather than waiting for the share price to drop below the SMA.
This sort of strategy requires more attention than buy and hold but may help investors go for the gains while managing the risk. Whipsawing is to be expected, but it’s better to pay a few dollars in brokerage fees from time to time than to potentially lose hundreds or thousands on price drops.
Disclosure: I do not own stock in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
Start a free seven-day trial of Premium Membership to GuruFocus.
