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I've got just one question for Bed Bath & Beyond (Nasdaq: BBBY ) shareholders today: Did you all read the same earnings report that I did?
Management reported its fiscal second-quarter earnings yesterday after close-of-trading, and at first glance, the news was simply terrific. Triple-B beat estimates by quadruple-cents -- earning $0.52 per share for its owners versus Street predictions of $0.48. Considering that comps declined a fraction of a percent and that overall storewide sales grew barely 3%, the 13% rise in quarterly earnings seems quite the neat feat. So why are investors unimpressed? Why's the stock down more than 4%?
I see two reasons.
Reason No. 1: Blame Wall Street
The simplest answer to the question of Bed Bath's decline is the fact that Credit Suisse downgraded the stock this morning. Calling the stock "expensive relative to Dick's Sporting Goods (NYSE: DKS ) ... O'Reilly Automotive (Nasdaq: ORLY ) ... Lowe's (NYSE: LOW ) ... and a few other names," the banker basically downgraded Bed Bath & Beyond on valuation.
And it's hard to argue with the logic. At 22 times trailing earnings, with long-term growth projected at less than 12%, the company does look a mite pricey. The analyst wasn't specific as to the "few other names" it was looking at, but more comparable retailers like Target (NYSE: TGT ) and Wal-Mart Stores (NYSE: WMT ) both carry significantly lower P/E ratios than Bed Bath. (Williams-Sonoma (NYSE: WSM ) , meanwhile, defies comparison with its P/E of infinity.)
Reason No. 2: Inventories
But if valuation is starting to become a concern, my own personal Bed Bath-bugaboo has finally been eliminated. Fact is, even as Credit Suisse loses faith in the company, I am actually becoming optimistic.
For months, I've harped on the issue of the business's stubbornly high level of inventories. The higher they towered, the more they threatened the firm's ability to maintain margins and deploy cash effectively. Yet in Q2, inventories declined 3% year over year, even as sales inched up. Free cash flow surged more than five times in volume, to $324.8 million in this year's first half. Add to this the $306.7 million the company generated in last year's fiscal second half, and you're looking at a retailer generating in excess of $630 million annual free cash.
Even after this year's considerable run-up in price, the Bed Bath & Beyond enterprise (market cap-net cash) sells for only 15 times trailing free cash flow -- not a bad price in the middle of the Great Recession. So while I agree with Credit Suisse that the company may not offer the best bargain in stock investing today, I emphatically disagree with investors' decision to dump the shares.
Just as Bed Bath & Beyond starts to get its act together is exactly the wrong time to sell.