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Bed Bath & Beyond's 2018 Forecast Is Terrible: Time to Sell?

By Adam Levine-Weinberg - Apr 18, 2018 at 6:10AM

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Management doesn't see any quick solution to Bed Bath & Beyond's recent trend of margin erosion. However, the liquidation of some major competitors could certainly help.

Last month, I bought shares of Bed Bath & Beyond ( BBBY 1.87% ). While the company's profitability has been under pressure, I believed that benefits from tax reform and a reprieve in competition would allow Bed Bath & Beyond to get back on track. Meanwhile, the stock was trading for just seven times earnings.

Instead, Bed Bath & Beyond stock plunged another 20% last week, after the company's guidance for the coming year came in well below expectations. The stock has now lost three-quarters of its value over the past three years -- and the company is still floundering.

BBBY Chart

Bed Bath & Beyond Stock Performance, data by YCharts.

Given Bed Bath & Beyond's unexpectedly bad forecast, it's sensible to reevaluate the investment thesis at this point. (Panic selling is hardly ever a good idea -- but holding on to shares of a failing company isn't wise, either.) However, despite Bed Bath & Beyond's poor outlook, I think the possibility of a turnaround justifies holding my shares until at least early 2019.

Decent earnings but terrible guidance

Bed Bath & Beyond's fourth-quarter earnings report itself was better than feared. Revenue came in at $3.72 billion, about 1% ahead of the average analyst estimate. Comp sales slipped just 0.6% year over year. Meanwhile, Bed Bath & Beyond posted full-year adjusted earnings per share of $3.12. This beat its forecast of $3.00 by a comfortable margin.

While these results were ahead of expectations, they still weren't very good. Just a year earlier, Bed Bath & Beyond had posted full-year EPS of $4.58. However, the retailer's forecast was an even bigger problem.

For the 2018 fiscal year, which began last month, management expects a return to modest comp sales growth but another sharp EPS decline. The company's forecast of full-year EPS "in the low-to-mid $2.00 range" -- which presumably means approximately $2.00-$2.50 -- came as a shock to investors, who were hoping that the worst was over. To add insult to injury, Bed Bath & Beyond expects EPS to decline again in fiscal 2019 before (hopefully) returning to growth in 2020.

A hand giving a blue-and-white Bed Bath & Beyond gift card to another hand

Bed Bath & Beyond expects earnings to decline for two more years. Image source: Bed Bath & Beyond.

Bed Bath & Beyond's strategy isn't very clear

On the company's recent earnings calls, management has spent plenty of time talking about Bed Bath & Beyond's turnaround strategy. Some elements make sense, like increasing the number of items displayed in stores while reducing inventory by carrying less backstock. This initiative should boost gross margin and cash flow.

However, other aspects of the strategy remain nebulous. For example, Bed Bath & Beyond executives have repeatedly talked about using "deep value" and "treasure-hunt" merchandise to drive store traffic. Those terms evoke the considerable success of off-price retailers, but it's not clear what they really mean in the context of Bed Bath & Beyond's business.

Additionally, the company's plan to add more food, health, and beauty products to its stores doesn't seem very different from what it has already done in recent years. Management hasn't adequately explained why it expects better results from this familiar strategy in the future.

Is the competitive environment about to get easier?

While Bed Bath & Beyond is still struggling to find its way, it's set to benefit later this year from the disappearance of two rivals.

First, Toys "R" Us is in the midst of liquidating its U.S. operations, including the Babies "R" Us chain. Bed Bath & Beyond owns the competing Buy Buy Baby big-box chain, which is likely to see strong sales and earnings growth -- and could benefit from new expansion opportunities -- once Babies "R" Us closes for good.

Second, department-store operator Bon-Ton appears destined for liquidation after it failed to find a buyer to rescue it from bankruptcy. Bon-Ton has generated 17% of its roughly $2.5 billion of annual revenue from its home department in recent years. After it liquidates, Bed Bath & Beyond will have the opportunity to compete for hundreds of millions of dollars of sales that will be up for grabs.

Bed Bath & Beyond also has hundreds of leases expiring in the next two years. As a result, it will be able to close some underperforming stores and stop competing with itself.

Even with all of these tailwinds, there's no guarantee that Bed Bath & Beyond will be able to return to sustainable earnings growth by 2020, as it plans. I'm willing to be patient for a while to see if Bed Bath & Beyond's turnaround initiatives -- combined with competitors' store closures -- can get results moving in the right direction again. But if there have been no tangible signs of a turnaround by this time next year, I'll probably cut my losses and move on.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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