Bed, Bath and Beyond Can't Find Footing
We're placing the retailer under review as earnings growth gets crushed by operating margin pressure.
Entering the third consecutive year of falling earnings per share growth, no-moat Bed Bath & Beyond (BBBY) continues to hit bumps in the road to recovery. While we have long contended there is a purpose in brick-and-mortar in the home furnishing space, the pace of competitiveness appears to be picking up, with Bed Bath’s ineffective responsiveness resulting in further compression in operating performance in 2018 and potential earnings per share declines through 2019 (or beyond). Previously, we had forecast low-single-digit declines in same-store sales, along with the closure of 30-50 stores per year, neither of which we expect to change materially. However, we only incorporated modest operating margin declines (to below 6%) over the next five years, which we now anticipate will fall even lower, to around a 4% level in 2018, and improving off of these deflated levels could prove difficult. We are placing our $27 fair value estimate under review as we reassess our long-term assumptions on Bed Bath. If we determine earnings power is set to be permanently reduced by one-third, we would expect a corresponding devaluation to our fair value estimate.
In this vein, we plan to lower our stewardship rating to Poor from Standard to reflect returns on invested capital that are set to fall below our weighted cost of capital estimate in 2018 (at about 7.5%), as it appears that capital allocation is no longer generating excess economic rents. With nearly all of the company’s board members sitting for 10 years or longer on Bed Bath’s board, we are discouraged that there hasn’t been more turnover, in light of performance in recent years. Without changes at the board level, we anticipate little in the way of adjustments surrounding the management team or allocation principles, which is the main factor that underlies our update.
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Jaime M. Katz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.