On Wednesday afternoon, Bed Bath & Beyond (NASDAQ: BBBY) reported another quarter of weak sales and plunging earnings. The bottom-line results were far worse than what analysts had expected. Furthermore, management acknowledged that earnings per share will likely come in near the low end of the company's full-year guidance range.
In response to this news, Bed Bath & Beyond stock plummeted as much as 25% on Thursday. The shares now trade for less than $15, a level not seen even during the Great Recession.
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By some measures, Bed Bath & Beyond stock looks cheap. Management is also working on some promising strategies to stem the bleeding. Nevertheless, investors should wait for clear signs of progress -- or a much bigger discount in the stock price -- before considering buying shares of this struggling retail giant.
Bad news all around
Bed Bath & Beyond reported total sales of $2.94 billion for the second quarter of fiscal 2018, in line with the prior-year period. Comparable-store sales slipped 0.6% year over year. This sales result was slightly worse than what management had expected. It also fell short of the average analyst estimate.
Meanwhile, profitability continued to erode. Gross margin fell to 33.7% from 36.4% a year earlier, which management attributed to factors including higher coupon expense and an increase in shipping costs related to higher e-commerce sales. Unfortunately, Bed Bath & Beyond's core merchandise margin also deteriorated last quarter. Lastly, operating expenses ticked up as a percentage of revenue, driven by investments the company is making to try to return to growth.
The net result was that pretax profit plunged by 57%. Even with the benefit of a lower tax rate and a lower share count (driven by stock buybacks over the past year), EPS fell to $0.36 from $0.67 in Q2 2017. Management said that this EPS result was in line with its internal model. However, analysts had been expecting EPS of $0.50, on average.
Looking ahead, Bed Bath & Beyond now expects full-year comp sales to be flat in fiscal 2018, compared to its previous forecast of low-single-digit growth. EPS is set to come in around $2, near the bottom of the "low-to-mid $2.00 range" from the company's initial forecast.
Analysts are fed up
Bed Bath & Beyond's management hasn't sugarcoated the company's challenges. Back in April, the company warned investors that EPS would fall to as little as $2.00 this year, down from adjusted EPS of $3.12 in fiscal 2017 and $4.58 in fiscal 2016. Furthermore, management stated that earnings will likely decline again in fiscal 2019 before finally returning to growth in 2020. This revelation caused Bed Bath & Beyond stock to crater for the first time this year.
However, Wall Street analysts are increasingly losing patience with Bed Bath & Beyond. EPS is still plunging (which is in line with the company's forecast), but that's not necessarily a reason to believe that management is on track with its plan to return to earnings growth by 2020.
An acceleration in the rate of gross margin erosion was particularly concerning in this regard. Some of this margin pressure is related to the cost of the relatively new BEYOND+ program, which provides free shipping and 20% off all purchases for $29/year. But management couldn't provide a straightforward explanation of why the company's core gross margin is still falling -- or what might eventually drive a rebound there.
Another point of contention was the lack of disclosure about the relative performance of Bed Bath & Beyond's various retail concepts. Management did note that buybuyBABY is performing well and capitalizing on the liquidation of the competing Babies R Us chain. Yet sales growth there implies that the company's other retail concepts performed worse than the corporate average.
Wait for signs of a turnaround
With its most recent plunge, Bed Bath & Beyond stock trades for a little more than seven times earnings. While that's a sharp discount relative to the broader market, the company does expect EPS to decline again next year. Depending on how far EPS falls in fiscal 2019, Bed Bath & Beyond stock's current multiple could still prove to be too generous.
This isn't to say that there are no bright spots. Free cash flow has been quite strong year to date. Some of that improvement relates to the timing of payments, but federal tax reform and Bed Bath & Beyond's inventory reduction plan have also helped boost cash flow.
The company is also piloting store format changes at Bed Bath & Beyond. The initial results in its test stores have been promising. Furthermore, the company plans to close up to 40 stores this year as it rationalizes its brick-and-mortar footprint. Over the next few years, additional store closures and store remodels could help drive a turnaround in profitability.
That said, changes in consumers' shopping patterns will continue to pressure sales and earnings at Bed Bath & Beyond for the foreseeable future. New tariffs on Chinese goods could further sap its profitability. Until the company shows clearer signs of progress toward a turnaround, Bed Bath & Beyond stock looks too risky relative to the potential reward.
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