Lowering Our Outlook for Bed Bath and Beyond

Jaime Katz: After recently re-evaluating our long term thesis on Bed Bath, we lowered our fair value estimate to $9.40 from $15.20. Originally, at the beginning of 2016, Bed Bath highlighted 10 different efforts that it was undertaking to improve its profitability profile. More than two years later, it's clear that even those efforts that we thought would have paid off have stalled.

Profitability has continued to wane at Bed Bath, with the firm's operating margin set to fall below 4% in 2018 from 14% in 2013, representing a more than 1,000-basis-point decline over a five-year period. Additionally, with same-store sales failing to crack the 2% mark since the first quarter of 2015, expense leverage has been difficult to come by.

Furthermore, in our base case, we believe declining same-store sales will persist over our forecast, as we expect declining traffic to hinder physical box performance, making the ability to raise operating margin performance from current levels difficult.

These issues have been the impetus in us lowering our outlook. Now our existing base-case scenario is one in which Bed Bath's management continues to initiate efforts to stem share losses, leading to a modest deceleration in both same-store sales and revenue as some consumer programs attempt to stem rapid market share declines. we now include modest annual downticks in the gross margin metric which falls to 33.4%.

Additionally, we altered our model to keep the SG & A ratio around 30.9%, as the company continues to spend to remain front of mind. Without much in the way in product differentiation, we don't believe the brand will remain sticky with consumers, which ultimately drives our operating margin forecast to fall below 3% over our explicit forecast.