EUR 850.00 For Business Accounts Only

Morningstar | Bed Bath Earnings Declines Are Slowing, But Profits to Remain Depressed in 2019; Shares Overvalued

No-moat Bed Bath & Beyond adjusted its prognosis for 2019, now anticipating earnings per share to be “about the same as fiscal 2018,” marking an improvement from its prior outlook for the firm’s pace of turnaround, sending share up at a double-digit clip. With the firm’s original intention of slowing declines in both operating margin and EPS over the next two years before growing EPS in 2020, we still believe we are a few quarters away from seeing any inflection point in financial performance, given the weak 1.6% operating margin the firm posted in the third quarter (representing a more than 200 basis point decline). With a 2018 EPS outlook that should remain around $2 the company expects (and in line with our prior forecast), we plan to keep our 2019 EPS estimate of $1.85 largely intact for now. This includes a 1.5% same-store sales decline (in line with the firm’s low-single-digit shortfall forecast) and operating margin performance around a mid-3% rate, in line with the 3.5% the company should be able to deliver this year. As efforts on technology and customer-facing initiatives start to stabilize the business, market share losses should moderate. However, we don’t expect competition across the overall retail environment should abate, perpetuating the need for spend to remain front of mind, keeping Bed Bath’s profit opportunity in a holding pattern.

In our opinion, Bed Bath remains overstored, and with less than 300 store closures in our 10-year forecast, we anticipate the firm’s operating margin could continue to dwindle, averaging 3%, as the store base becomes less traveled and inflated shipping costs weigh on e-commerce costs. Additionally, with a fragmented home furnishing marketplace peppered with peers willing to spend aggressively for customer acquisition, we suspect it will remain difficult for Bed Bath to capture pricing or scale gains from current levels and plan no major change to our $9.40 fair value. In this vein, we view shares as overvalued.

While the prognosis for Bed Bath’s earnings growth ahead has improved, the fiscal third quarter felt many of the pressures the company has persistently seen in recent periods. Same-store sales declined 1.8% during the period, on top of a 0.3% decline in the third quarter of 2017 and 1.4% downtick in 2016, leading to sales growth of 2.6% in a quarter that benefited from a calendar shift from the 53rd week in 2017. The gross margin rate contracted 210 basis points, to 33.1%, marking the lowest third-quarter performance in the last decade as the merchandise margin contracted and coupon expense again increased (with an increase in the amount and decrease in the number of redemptions). Also posting close to record highs (the third quarter of 2017 was 10 basis points higher) was the selling, general and administrative ratio, at 31.5%, hindered by incremental advertising costs shifted to the quarter due to new revenue recognition standards. Ultimately, this led to a bare-boned 1.6% operating margin in the period, indicating the worst was not behind the firm in the most recent quarter.

In fairness, the company is attempting to stay relevant, testing new concepts in its lab locations, upgrading its technology, and re-evaluating its real estate portfolio (an area we think the company should be able to squeeze meaningful economics from, given the shrinking brick-and-mortar demand landscape). We contend, however, that the lack of product differentiation and little in the way of switching costs remain a headwind for the business (also impacting other peers in the space including Wayfair, Pier 1, and other home furnishing retailers) that will be difficult to conquer. In November, we published a report titled, “Profits at Bed Bath Hampered as Customer Traffic Moves Beyond,” reassessing our long-term thesis on the business. We noted that in recent years, we had seen some retailers pivot to defend their positions and others persistently cede share. In our opinion, no-moat Bed Bath & Beyond fell squarely into the latter category, failing to adapt to evolving consumer preferences or differentiate its product offerings. After evaluating terminal outcomes that included bankruptcy longer-term, steady-state performance declines, and turnaround metrics considered, we didn’t think there was significant value left to be unlocked, given the firm's current strategic direction. In turn, we then lowered our fair value estimate to $9.40 per share from $15.20, given our expectation for the long-term trajectory of Bed Bath’s earning power was worse than we previously expected. Despite management’s sentiment that the tide appears to be turning for Bed Bath, we remain cautious on shares given the company’s inability to stem share losses and stimulate earnings growth in recent years.