One of the retail stocks I frequently analyze just released its earnings. Bed Bath & Beyond’s (BBBY) second quarter EPS came in well above expectations, but both sales and earnings were down significantly. Same store sales were a disaster while gross margins were stable. I have been negative for a while, but I am rooting for management to finally turn things around. That said, I cannot find enough evidence to advise you to buy this stock at this stage.

Source: Bed Bath & Beyond

The Store And The Stock

I like stores like Bed Bath & Beyond (NASDAQ:BBBY). Its product portfolio is huge, and everything you need is right there. Unfortunately, a lot of things you can buy at Bed Bath & Beyond are cheaper on the internet and the uniqueness of the store is rapidly declining as a lot of retailers are reinventing themselves to offer a unique shopping experience. This sure is one of the aspects that is open for debate as I have met plenty of people who either love going to Bed Bath & Beyond or who absolutely hate it.

Simply put, the largest problem retailers have is the declining trend of margins. It started in 2015, but peaked later in 2018. Anyhow, as the economy started to weaken in Q4 of 2018, a lot of companies got additional pressure from falling sales. That’s pretty much a worst-case scenario which obliterates the bottom line.

Bed Bath & Beyond is struggling with falling margins as well as falling sales and is taking hard measures to turn things around.

This company with a short float of 55% has reported declining earnings in every single quarter over the past few years if one excludes 0% growth in FQ4/16. Most of the time, the company even managed to beat earnings. The just-released FQ2 adjusted EPS results were also higher than expected. The company’s adjusted EPS result came in $0.08 above expectations but 6% lower compared to the prior-year quarter.

Source: Estimize

Weakness was caused by very weak sales. Net sales came in at $2.7 billion, which is a decline of 7.3%. This is the third consecutive quarter of negative growth after 7% contraction in the prior quarter and 11% contraction in the last quarter of FY 2018. In this case, comps were down 6.7%, which includes a high-single digit decline of in-store sales and a slight decline of digital channel sales. In other words, comps and even online sales were down.

The good news is that gross margin improved by 20 basis points compared to the prior-year quarter as several ongoing margin enhancement initiatives became tailwinds.

And speaking of tailwinds, the company’s cost structure optimization efforts including lower payroll and occupancy expenses lowered SG&A expenses by $47 million. Unfortunately, as sales were down much more, this still pressures operating margin. Adjusted operating margin fell by 50 basis points to 2.3%. Net margin reached 1.5% which is 30 basis points lower.

The good thing is that these measures (and I will discuss more in this article) have caused retail inventories to decline by 18% which will be a benefit going forward. Both for merchandise margins as well as total SG&A expenses.

To turn the company around, the company is implementing growth measures. The first priority aims to stabilize sales and to drive top line. The company is refreshing 160 of its best performing stores by enhancing technology and to improve overall traffic growth. This also includes the implementation of performance incentives for store managers and additional marketing and promotional support. And you probably already guessed it, the long-term plan is to implement successful measures in all stores.

Top-line growth is one thing, but even more important might be the cost structure. In this case, management is working to optimize real estate costs by renegotiating all leasing, including those with long-term leases. Expected occupancy cost savings will likely benefit the company on a full-year 2019 basis and beyond. Cutting costs also includes a reduction of overhead costs. The company completed a workforce reduction of 7% which includes employees of all types ranging from staff to executives. In the remaining 2 quarters this fiscal year, the company aims to outsource an increasing number of tasks.

In addition to that, the company is aiming to penetrate the market by offering proprietary home furnishing brands. The first 3 of 6 brands will be launched in 2019 and 2020 and are called Bee & Willow, One kings Lane and Marmalade. Although it is hard to say how this will impact results, I think it gives the company more control over its products and costs, which might be a benefit going forward.

And speaking of Bed Bath & Beyond’s product portfolio, its third priority is based on enhancing the asset base including portfolio of retail banners. Over the next 18 months, Bed Bath & Beyond aims to reduce $1 billion worth of inventory. In the second quarter, the company reduced inventory by $194 million. Before the holiday season, $350 million of inventory will be removed. Lower inventories will allow in-store employees to focus more on customer support and drive sales. The other benefit is that new products can be added which will hopefully continue to improve gross margin.

The fourth and last priority is the goal to improve the organization structure which aims to have the right talent and expertise as well as the right team structures to make the organization more efficient.

All things considered, the company expects to generate sales worth $11.4 billion on a full-year basis. Previous expectations aimed to grow sales to $11.4 billion to $11.7 billion. Diluted EPS is expected to come in between $2.08 and $2.13, which is down from previous expectations of $2.11 and $2.20.

The Bottom Line

I don’t think the company is a buy at this point. The company is struggling to raise margins, and sales have shown some serious contraction over the past 3 quarters, which is crushing the bottom line. Yes, the stock is trading at less than 5x next year’s earnings, and a short float of 55% is making short squeeze extremely painful for bears. That’s why I am not shorting. The best way is to ignore the stock for the time being. We first need positive results from the company’s growth measures. Even if the company turns out to be successful – and I hope they are – there will still be enough potential profits for bulls. I might be less willing to take big risks than others, but I think money on the sidelines (or in better stocks) is a better option than buying this ultra volatile stock in the first stages of a potential recovery.

Source: FINVIZ

The risk/reward is not interesting enough and I need more evidence before I start buying. Next quarter, I hope the company is able to report better sales, which would be a first step towards higher bottom-line growth.

Stay tuned!

Thank you very much for reading my article. Feel free to click on the “Like” button and don’t forget to share your opinion in the comment section down below!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.

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2019-10-04