Bed Bath & Beyond (NASDAQ: BBBY ) is issuing $1.5 billion in debt to finance an accelerated share buyback program. The decision comes at a time when Bed Bath & Beyond is trading at depressed valuation levels due to disappointing financial performance, and companies such as Pier 1 Imports (NYSE: PIR ) and Lumber Liquidators (NYSE: LL ) are confirming that the environment remains notoriously challenging for retailers exposed to the real estate market.
Is Bed Bath & Beyond making a smart decision in terms of capital allocation, or is it a short-term corporate gimmick to inflate the stock price?
Selling bonds and buying stock back
Bed Bath & Beyond is issuing $1.5 billion in long-term debt to finance share repurchases. The bonds will have three different tranches. The first tranche of $300 million matures in 2024 and pays an interest rate of 3.749%. The second one is also for $300 million; it matures in 2034, and pays 4.915%. The third tranche is for $900 million; it matures in 2044, and has been priced to yield an interest rate of 5.165%.
Bed Bath & Beyond has traditionally been very active when it comes to buybacks: The company has returned approximately $6.6 billion to shareholders via repurchases during the period starting in 2004 to the first quarter of 2014. However, Bed Bath & Beyond has always financed these buybacks via internally generated cash flow, so the decision to issue debt and accelerate repurchases is an important change in its capital allocation policy.
Bed Bath & Beyond is down by 24% year to date, as the company is reporting disappointing financial performance. Sales during the first quarter of 2014 came in at $2.66 billion, an uninspiring increase of 1.7% versus $2.61 billion in the same quarter of 2013. Comparable-store sales were almost flat, increasing only 0.4% versus the year-ago quarter.
Forward guidance was also uninspiring. Bed Bath & Beyond expects comparable sales to increase between 1% and 3% during the second quarter, and by approximately 3% for the full year.
Many other retailers linked to the housing market are also facing difficulties. Pier 1 announced lower-than-expected sales and earnings for the quarter ended on May 31. Sales came in at $419.1 million versus $394.9 million, which was forecast on average by Wall Street analysts. Earnings per share of $0.16 were also materially below expectations of $0.20 per share.
Alex W. Smith, CEO of Pier 1 Imports, said in the earnings press release that industry conditions remain notoriously challenging: "The retail environment remains highly promotional and is pressuring gross profit in the near-term."
Lumber Liquidators crashed last week, as the flooring specialist announced disappointing financial performance for the second quarter. Lumber Liquidators announced that total sales during the second quarter increased 2.3%, to $263.1 million, while sales at comparable stores fell by a worrisome 7.1% during the period.
Like Pier 1 Imports, Lumber Liquidators is blaming its disappointing performance on a weak environment:
Customer traffic to our stores was significantly weaker than we expected, particularly in geographic areas severely affected by the unusually harsh weather in the first quarter. The improvement in customer demand we experienced beginning in mid-March did not carry into May, and June weakened further. Our reduced customer traffic has coincided with certain weak macroeconomic trends related to residential remodeling, including existing home sales, which have generally been lower in 2014 than the corresponding periods in 2013.
An opportunistic decision
Based on valuation ratios such as price-to-earnings and price-to-free cash flow, Bed Bath & Beyond is trading at historically attractive valuation levels. This means the stock offers substantial upside potential if financial performance improves in the coming quarters.
Judging by recent reports from Pier 1 Imports and Lumber Liquidators, the industry is going through a particularly challenging period. This may be indicating that recent financial weakness is mostly due to temporary and external factors.
It's hard to tell how long it will take for the industry landscape to improve, but Bed Bath & Beyond has a solid balance sheet, and it's still generating healthy cash flow, so liquidity and financial risk are no big reasons for concern. Over the long term, chances are that the stock should trade at considerably higher levels as things turn for the better regarding overall industry demand.
Based on these considerations, it looks like Bed Bath & Beyond is capitalizing on the opportunity to issue debt at historically low interest rates and repurchase its shares at a conveniently attractive valuation.
Issuing debt to repurchase stock usually raises some eyebrows among investors. This is understandable, because companies can abuse this strategy as a method to artificially inflate the stock price. However, Bed Bath & Beyond seems to be doing the right thing by capitalizing on the opportunity to repurchase shares at historically attractive valuation levels. If the recent slowdown in growth is only transitory and due to external conditions, investors should be well served by this decision.
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