Fool on Call: Bed Bath & Beyond's Tub Not Full Yet

Bed Bath & Beyond (Nasdaq: BBBY  ) recently released its fiscal 2006 third-quarter earnings report, and while the numbers were not blistering hot, it's hard to complain about double-digit top- and bottom-line growth. In his analysis of the results, my Foolish colleague Ryan Fuhrmann believes that investors can still win with this home-furnishings retailer: "My money is on 10% or more growth for at least the next five years," he wrote, "in which case Bed Bath should duly award long-term shareholders."

To obtain a better understanding of its growth initiatives, we will dive into the company's latest quarterly earnings conference call. Regrettably, management chose not to engage with analysts using a question-and-answer session, which often reveals some of the best information as to what's really going on with a company. That said, there is enough still here to help us achieve a clearer picture for its growth initiatives during the remainder of the year and for FY 2007.

We will break down our discussion of the call into the following two areas:

  • Growth initiatives for the remainder of FY 2006.
  • Growth initiatives for FY 2007.

Coming up short in 2006
During Bed Bath's first-quarter conference call we learned that the company was revising its 2006 new-store development plans downward to a range of 75 to 80 stores. One of the stated reasons for the revision was that the rising costs of raw materials have negatively affected construction and occupancy expenses. Because of these external forces, management admitted at the time that even more planned openings may have to be delayed.

During the third quarter call, it was revealed that the company plans to open 18 new Bed Bath & Beyond stores in Q4. This would bring the total openings for the full fiscal year to 72, short of its previously revised unit-growth projection.

Management also added that the capital to pay for these new-store openings is coming from the company's cash generation. For years, Bed Bath has chosen to fund expansion through its cash flow, which is why it remains debt-free today.

There's something about a balance sheet that tickles an investor's fancy when it shows roughly $1.1 billion in cash, cash equivalents, and investment securities, coupled with no long-term debt. But one could argue that the decision to remain entirely debt-free was not the optimal capital structure to use, given the company's ability to generate cash.

Debt leverage can be a powerful means to drive growth, either through even greater organic expansion or through acquisitions. That's why, when interest rates began falling to record lows just a few years ago, many companies looked to lock in debt at the lower rate and expand the opportunities for growth today.

Now with interest rates on the rise, one might view Bed Bath's squeaky-clean balance sheet as a missed opportunity. Perhaps instead of the 72 units it will open in 2006, with a combination of its existing cash flow as well as low-interest debt, it could have opened 100-plus stores and thereby increase its top-line growth. Well, it is what it is, and quite frankly, it's hard to get too upset over a clean balance sheet.

It may be a bit of a disappointment to see Bed Bath come up shy on its projected growth expansion for the year, but there is at least one positive that comes from it: Capital expenditures for the year will also be lower than expected, which will lead to higher-than-anticipated amounts of free cash flow. Now management expects capex for the full year to come in at $300 million, well below the previously estimated $350 million.

This should alleviate some of the concerns that Ryan has been having over the company's recent dip in free cash flow production. Of course, what is scheduled for expensing this year will most likely show up in next year's capex line.

Different year, same routine
As you look out into 2007, don't expect too much to change. Management is looking for top- and bottom-line growth of 10% for the fiscal year, which will be made possible through a combination of comparable same-store sales growth and new-store openings.

Comps for its Bed Bath stores are expected to increase 3% to 5% for the year. Additionally, it plans to add 70 new Bed Bath units, bringing the total by the end of 2007 to 883. Add 8.6% unit growth with 3% to 5% in comps growth, and we should expect the company to top its 10% sales-growth forecast -- that is, unless its Harmon Stores and Christmas Tree Shops end up being a drag on sales.

Management does expect operating margins to be weaker in 2007. No reasoning was offered for the decline, but if we look at recent trends, including the legal and accounting expenses related to the review of its stock options, stock-based compensation expenses, and an increase in advertising caused by increased paper costs and postal rates, it is likely that these will continue to have an impact in 2007.

While net earnings growth is estimated to be about 10%, earnings-per-share growth should actually come in much higher. The company just announced another major share-repurchase program of $1 billion that will likely take two years to fully implement. This program follows on the heels of its previous $950 million buyback plan.

With fewer diluted shares outstanding, shareholders will be beneficiaries of a larger part of the earnings pie.

A simple plan
Bed Bath & Beyond has a simple winning strategy that it has been employing for years: Build stores; increase its buying power; leverage its sales, general, and administrative expenses; generate cash; and build more stores. Other concepts, such as Cost Plus (Nasdaq: CPWM  ) , Pier 1 (NYSE: PIR  ) , Bombay (NYSE: BBA  ) , Restoration Hardware (Nasdaq: RSTO  ) , and Linens n' Things, employ a similar approach, but not with equal success.

Shareholders should expect Bed Bath & Beyond to continue along the same lines as it looks to top 1,300-plus stores, giving it a good chance to be a solid performer for at least the next few years.

For related Foolishness:

Bed Bath & Beyond is both aStock Advisorand anInside Valuerecommendation. To see why, why not take a trial of both? After all, they're both free for the first 30 days!

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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