Bed Bath & Beyond Inc. The company entered the coronavirus crisis with the need to significantly improve its merchandising and e-commerce capabilities. New CEO Mark Tritton has been moving quickly and aggressively to cut costs and generate cash by restructuring operations, cutting inventories, selling real estate, reducing debt and selling an ancillary business.
The COVID-19 epidemic is likely to make his job more difficult. Even before COVID-19, and the lockdown period that caused stores to close, store traffic had been very disappointing. We view traffic or transactions as a key indicator of a retailer’s relevance to its customers. On the plus side the pandemic-related shutdown sent a lot of shoppers online to find products, and the benefit of stimulus checks may have made shoppers less price sensitive and helped margins.
Walmart, Costco and Home Depot are examples of retailers that meet these criteria.
The company will host a virtual investor day on October 28. We expect BBBY to share its three-year plan, which could be a catalyst for the shares. Investors may be listening for signs that the board is thinking about resuming dividend payments or share repurchases.
On October 1, BBBY reported a 2Q21 adjusted profit of $0.50 per share. In the prior year, the company had an adjusted profit of $0.34 per share.
Why did the shares jump almost 25% after the earnings report? In addition to the better-than-expected results, short sellers may have scrambled to cover their obligations amid signs that the company was able to generate digital growth and that the new management team seems to have a more data-driven approach to merchandising and promotions.
Earnings benefited from the divestiture of PersonalizationMall.com and a gain on the extinguishment of debt. There was some offset from the impairment of trade names.
Sales of $2.69 billion declined by 1%, hurt by the divestiture of One Kings Lane, which was better than our expectation for sales of $2.45 billion. One positive surprise was 21% growth in back-to-college merchandise despite the pandemic. The company noted that sales in the Baby business represented about 10% of the company’s total.
Comparable sales were up 6%, which was the first positive performance since 4Q16. In-store sales declined by 12% on a comparable basis. Online sales rose 89% on a year-over-year basis reaching about a third of the company’s total. Bed Bath gained about 2 million new online customers in 2Q.
The improvement came despite a higher mix of online sales. The company had a more favorable product mix and better management of markdowns, including lower coupon expense.
Adjusted selling, general and administrative expense came to 31.5%, which was down about 10 basis points from 2Q20 and lower than our estimate of 32.1%. The StreetAccount consensus was 31.6%. The company reduced payroll and advertising expense.
The adjusted operating profit was $114 million, compared with our estimate for a loss of $50 million. The company’s tax rate was 34.3% of earnings before taxes. Our estimate was 26%.
Management said the company generated over $175 million of cash in 2Q. BBBY used cash to repay $300 million of bonds and a $236 million bank loan.
EARNINGS & GROWTH ANALYSIS
Our estimate is on an adjusted basis and excludes business transition expenses. Second-quarter results were substantially better than we expected. We are reducing our 3Q loss estimate and raising our 4Q profit forecast based on stronger sales forecast and a higher gross margin based on signs of progress in managing promotions.
We expect stronger online sales and a slightly higher gross margin on better promotions and greater acceptance of curbside and buy-online-pickup-in-store. BBBY also have should have better merchandise. An offset is that the company will be closing stores. The company will be working to retain a portion of those sales at nearby stores and online.
We recently lowered our five-year EPS growth rate estimate to zero from 8%. We are not currently changing this number in light of COVID-19 concerns.
FINANCIAL STRENGTH & DIVIDEND
It had total liquidity of about $2.2 billion including cash and available capacity on the new revolving credit facility.
We expect BBBY to focus on strengthening the core business and increasing financial flexibility. Bed Bath has suspended the dividend. We think that was a prudent decision. Maintaining financial flexibility is more important. Share repurchases are typically made when a company has excess cash after capital spending and dividends. We expect an update on BBBY’s capital allocation plans at the upcoming investor meeting.
The new facility matures in 2023 and was used to refinance $236 million of borrowings on the previous $250 million facility.
In November of 2019, Standard & Poor’s cut Bed Bath’s credit rating to BB, which is below the investment-grade range. The rating is now B+. The outlook is negative. The Moody’s rating is Ba3, three notches below the lowest investment-grade rating.
Investment-grade ratings are important; they make it easier for companies to make deals and finance new projects and they provide access to commercial paper and other financial markets, which allow the company to maintain a more efficient balance sheet.
Investment-grade ratings also make it easier to borrow new money or refinance existing debt because there are many investors who can only own investment-grade bonds.
The company has operating leases, which Argus treated as debt for many years before newly adopted accounting guidelines required the company to recognize the asset and liability values of leased assets on the balance sheet rather than treating them as off-balance-sheet items.
Our current estimate of adjusted EBIT is still negative for FY21, but adding back D&A of approximately $340 million and rent of about $534 million should take adjusted EBITDAR and potentially adjusted EBITDA positive territory.
The company repurchased $2.2 billion of common stock in FY15, including $947 million in 4Q. BBBY repurchased $1.1 billion. It repurchased $550 million in FY17, $207 million in FY18, $148 million in FY19, and about $100 million in FY20, leaving it with a remaining authorization of about $1.2 billion. We believe that reducing debt and getting the credit ratings back into investment-grade territory is more important than repurchasing shares.
We would not rule out the possibility of the board reinitiating the dividend.
MANAGEMENT & RISKS
The biggest risk currently facing BBBY is that store traffic was weak and the stores were underperforming in the strong economic environment before the pandemic. The company’s online business did pick up some slack in 1H. But competition from Amazon, Target, Williams-Sonoma and Wayfair remains intense.
The company has hired some very capable executives and we believe that shoppers are willing to spend to make their homes safer and more comfortable. We also expect U.S. consumers to be eating more meals at home for the foreseeable future. This could be beneficial to sales of everything from espresso makers to spatulas, but BBBY must reestablish itself as a destination for innovative, well-priced merchandise and use analytics to drive add-on purchases and repeat business.
Calendar 2019 was a tumultuous year for Bed Bath. The company’s founders lost their seats on the board and CEO Steven Temares stepped down under pressure from activists. The company initially appointed Mary Winston as Interim CEO and named Mark Tritton as president and CEO in October. Mr. Tritton, who was also added to BBBY’s board, was most recently the chief merchant at Target and previously EVP of Nordstrom’s Product Group.
The board has been expanded to 14 members from 10 last year. It includes 13 directors who were added in the prior two years, and just one with a tenure greater than three years (Independent Chairman Patrick Gaston, who has been a director since 2007). The new board is more diverse and very qualified. It includes seven women, which we view as important for a company whose customers are mostly women.
On February 27, Mr. Tritton announced a major restructuring plan including the elimination of about 500 jobs. The goal is to reduce SG&A by about $85 million and ultimately save several hundred million dollars. Having a lean cost structure is incredibly important. The company must also have the right cost structure for the likely size of the business going forward.
On March 4, Bed Bath named Joe Hartsig as chief merchandising officer for the entire company, and president of the company’s Harmon Stores, which sell cosmetics, health, and beauty products. Mr. Hartsig was most recently the chief merchant at Walgreen’s, where he was responsible for Walgreen’s front-of-store merchandise. His goal will be to differentiate the company’s product assortment as rival Williams-Sonoma’s West Elm chain has done so well. The company also used the word ‘curate’ in the press release. To us, that means that it will probably de-clutter the stores, which will be a source of cash as the company sells through merchandise and doesn’t replace it.
On April 21, BBBY appointed John Hartmann as chief operating officer. Mr. Hartmann joined Bed Bath from True Value, where he modernized the hardware’s supply chain. He has also held senior positions at Home Depot, Cardinal Health and the FBI. Robyn D’Elia signed the 10-K as CFO and Treasurer on April 29. On April 30, the company announced that she would be replaced effective May 4 by Gustavo Arnal. He was previously CFO at Avon, and has also held senior positions at Walgreens Boots and Procter & Gamble.
Bed Bath is successfully recruiting managers and merchants to lead the turnaround. The fact that BBBY is attracting talent is an endorsement for CEO Tritton’s vision.
On July 13, the company announced that it hired Neil Lick to develop and launch private brands. He spent 22 years at Williams-Sonoma.
On August 3, BBBY announced that it completed the sale of PersonalizationMall.com. On August 25, the company announced that it was cutting about 2,800 jobs across headquarters and stores. The move is expected to reduce SG&A by $150 million annually as part of the previously announced plan to improve EBITDA by $250-$350 million (excluding one-time costs) over the next two-to-three years.
On September 2, BBBY announced that it hired Wade Haddad to lead the company’s initiative to close unproductive stores, reposition some stores, office space and distribution centers and equip the remaining locations to support ecommerce including curbside pickup and in-store pickup of online orders.
On September 14, Bed Bath appointed Juan Guerrero as Senior Vice President and Chief Supply Chain officer. His job is to modernize the company’s logistics and infrastructure network. It will be a big job. The company was historically decentralized. On September 17, the company announced that it expanded its relationship with Google Cloud. The company hired Deloitte as a consultant to help with customer analytics, personalizing ecommerce, and improving fulfillment strategies.
On September 23, the company appointed Scott Lindblom as Chief Technology Officer. Mr. Lindblom was previously Chief Information Officer at Michael’s and Group Vice President of IT at Ross Stores.
One lesson we have learned over the years is that consumer companies can’t cut their way to prosperity. The biggest problem facing Bed Bath is internet competition. It isn’t just that there are more vendors selling more stuff (and there are), BBBY is chasing the competition, rather than leading it, and facing escalating costs to play a game it used to dominate. With his background as a merchant, Mr. Tritton should be inclined to invest as well as cut.
The growing popularity of web shopping has certainly coincided with a period of weak store traffic across retail, and particularly at Bed Bath. This trend will be taken to an extreme while coronavirus is contagious or perceived as being contagious. A consequence is that the company’s merchants have always done a great job of selling in-store shoppers more than they planned to buy, and often at an attractive margin to the company. When foot traffic is weak, the company loses the ability to sell high-margin snacks, gadgets and accessories to buyers making an impulse decision. The company is trying to replicate the treasure hunt experience online, but it is hard to replicate the pull of gummy bears or cashews at the end of a work day or when you and your child have been shopping for a few hours.
We believe that Bed Bath’s historical edge has come from the merchandising skill of its store managers, who can make decisions based on local demographics. The company is playing catch up in developing analytics and distribution capabilities and that spending is weighing on earnings.
BBBY faces competition from Williams-Sonoma, Restoration Hardware, Pottery Barn, Macy’s, Wayfair, and the Home Goods chain that is owned by TJX. At this point, we are also concerned about competition from stores such as Wal-Mart, Target, Kohl’s and Lowe’s which are selling an increasing range of decorating items. We don’t believe that any of these retailers are likely to match BBBY’s full line of product offerings or consistently match the company’s merchandising of core products, but in the current online environment they can post furniture or other products on their website and have those items shipped directly from the manufacturers.
Computer hackers are a growing threat in retail and BBBY could see its costs rise and its reputation suffer if hackers breach its computer system and take customer credit or debit-card data. The company must also make sure that it keeps its physical warehouses and stock rooms secure as theft has been a growing concern for a number of retailers.
Saturation is another risk that we will be monitoring and BBBY, like all other traditional retailers must make hard decisions on what its store portfolio should look like.
MANAGEMENT & RISKS
In five years.
One risk that management can’t control is weakness in consumer spending. Concerns about COVID-19 may hurt BBBY in two ways: reduced store traffic and a potential loss of online business to retailers with more developed online offerings. High cotton prices represent a risk to gross margin if the company can’t pass higher merchandise costs on to shoppers.
KPMG has been the company’s auditor since 1992.
The company also sells china, small appliances, other household products and specialty foods and beverages. Fiscal 2020 ended on February 29, 2020.
BBBY shares have risen about 8% this year on signs that the company’s turnaround plan is gaining traction.
Valuing Bed Bath is a difficult task, but let’s assume that the company earns $1.00 per share in FY23, which is slightly above consensus and a year earlier than we modeled previously and $2.00 in FY24, which is a scenario we considered in our previous note.
Before coronavirus, management was aggressively working to generate shareholder value.