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Morningstar | New Leadership Continues to Attempt Turnaround, but Bed Bath Remains a Show-Me Story

With the business still undergoing a long-lasting turnaround, no-moat Bed Bath posted another difficult quarter, with same-store sales declines of 6.6% (below the 5% downtick we forecast) and persistent margin pressure. An adjusted operating margin of 1.6% slid 130 basis points versus the first quarter last year, with gross margin contracting 50 basis points, to 34.5%, and the adjusted selling, general, and administrative ratio expanding more than 100 basis points to 32.9%, reaching levels that were worse than during the throes of the last housing downturn. With updated company guidance calling for the low end of its prior outlook of $11.4 billion-$11.7 billion in sales and $2.11-$2.20 in EPS, we don’t plan to materially alter either our $11.4 billion sales outlook or our $1.95 EPS forecast, given the downside risk the company still faces in resurrecting profitability. We don’t anticipate any major change to our $10.80 fair value estimate and view shares as fairly valued, trading at about 5 times our 2019 EPS estimate, given our forecast for a 2% average EPS decline over the next five years.

While four key priorities were outlined—stabilizing sales, improving the cost structure, optimizing the asset base, and redesigning the organizational structure—we think such efforts will take time and are unlikely to halt the languishing relevance of the brand over the near term, particularly while the search for a permanent CEO continues. With Bed Bath continuing to operate in competitive categories, we expect it will be difficult for the company to raise its profitability profile, given weak pricing power and the need to reinvest in the business and spend on marketing to restore brand awareness, keeping operating margin in the range of 3%, in our view. This, in turn, should keep ROICs at a mid-single-digit level, below our 8% weighted average cost of capital assumption, implying economic value could continue to be destroyed.

Results indicate that the company isn’t close to out of the woods on its turnaround. During the quarter, Bed Bath reported a $3.03 per share impairment charge for goodwill and other intangible assets as well as severance (prior CEO Steven Temares took a significant payout in his departure) and shareholder activity costs. But even excluding these charges, EPS declined more than 60% from $0.32 in the first quarter last year. Additionally, we could see minor additional one-time items as the company finds ways to more efficiently run the business with outside partners bringing a fresh set of eyes to the operation.

We commend Bed Bath for taking the high road in response to pressures from the three-party investor group (Legion Partners, Ancora Advisors, and Macellum Advisors) pushing the company to refresh its leadership team, as it has opted to cooperate as partners to improve the business. Since calling for the removal of the longtime CEO and entire board of directors in March, founders Warren Eisenberg and Leonard Feinstein have stepped down as co-chairmen and directors, Temares has stepped down, and 12 of the 13 directors set for election are fresh to the firm, having been appointed within the last two years. But even with a fresh leadership team untied to prior efforts, and willing to effect change, we surmise footprint declines across commodity product categories in brick-and-mortar businesses are likely to persist.

In recent years, some retailers have pivoted to defend their positions and others have persistently ceded share as their competitive positions have waned, a topic we discussed in our November 2018 report “Profits at Bed Bath Hampered as Customer Traffic Moves Beyond.” We contended that Bed Bath fell squarely into the latter category, failing to adapt to evolving consumer preferences or differentiating its products, with sales that have risen just 1% on average and operating margin that has compressed more than 1,000 basis points to 3.5% over the last five fiscal years. Even with changes stemming from partnering with the activist investor group, we think unwinding decades of inefficient processes and the underinvestment in marketing and advertising are likely to continue to weigh on performance over at least the next year, as new leadership attempts to right the ship.