After a dismal performance in fiscal 2019, Bed Bath & Beyond (BBBY 7.18%) got off to an awful start in fiscal 2020. The COVID-19 pandemic caused sales to plunge 49% in the first quarter, leading to a $243 million adjusted net loss and a $302 million net loss under generally accepted accounting principles (GAAP).
Bed Bath & Beyond made a big comeback in the second quarter, surprising analysts with comparable sales growth and a quarterly profit. Bed Bath & Beyond stock jumped 38% in the two days following the earnings report last week, rallying to a 52-week high. However, investors may be overestimating the company's turnaround progress. Bed Bath & Beyond is not out of the woods yet.
A bounce-back quarter
Bed Bath & Beyond generated decent store traffic in the second quarter, despite the pandemic, with in-store sales down only 18% year over year. Meanwhile, digital sales surged 88%. As a result, comparable sales rose 6%, although net sales still declined 1% due to divestitures and store closures.
Additionally, the company's efforts to reduce product costs, limit markdowns, and optimize distribution costs started to bear fruit last quarter. Adjusted gross margin increased by 2 percentage points year over year, reaching 35.9%. Bed Bath & Beyond also reduced operating expenses by 3.5% compared to the prior-year period, enabling it to post adjusted earnings per share of $0.50: up 47% year over year. On average, analysts had been expecting a loss of $0.23 per share.
Bed Bath & Beyond also improved its balance sheet significantly during Q2. The company completed the sale of PersonalizationMall.com for $245 million. It used the proceeds to repurchase $300 million of debt at a discount to face value. The iconic retailer also generated over $500 million of free cash flow last quarter, more than offsetting its Q1 cash burn of $437 million. This allowed it to end the period with nearly $1.5 billion of cash and investments, compared to only $1.2 billion of debt.
Long-term threats remain
Between its stabilizing results and solid balance sheet, Bed Bath & Beyond has plenty of runway to execute its turnaround strategy. However, while it's not at risk of financial distress in the near-term, the company faces significant long-term headwinds that will be tough to address.
First, the COVID-19 pandemic has boosted sales of decor and other home furnishings. People who have been cooped up at home and reduced their spending on travel, restaurants, and other experiences have redirected spending to their homes. That clearly helped Bed Bath & Beyond last quarter. However, the trend may not last. In fact, the pendulum could swing in the other direction by this time next year -- assuming the pandemic has been tamed by then -- with people reverting to spending more on experiences.
Second, Bed Bath & Beyond will continue to face brutal competition from low-margin online pure-play retailers, discounters like Target, and (especially) off-price giant HomeGoods. The TJX Companies subsidiary did more than $6 billion of sales last year and sees room to expand its store count by more than 50% in the years ahead. A good chunk of that growth could come at Bed Bath & Beyond's expense.
Third, without high-frequency product categories like Target or deep discounts like HomeGoods, Bed Bath & Beyond will likely struggle to drive store traffic. Leaning too much on e-commerce to compensate for weak traffic would lead to margin pressure, particularly for orders shipped to customers' homes.
Promising steps, but lots of work ahead
Last year, Bed Bath & Beyond posted meager adjusted EPS of $0.46, down from $1.97 a year before. In fiscal 2020, the retailer's big Q1 loss virtually guarantees that it will post an adjusted net loss for the full year.
In recent months, Bed Bath & Beyond executives have outlined plans to close 200 underperforming stores, cut costs by hundreds of millions of dollars, streamline the merchandise assortment, and invest in store remodels and omnichannel initiatives to drive sales and earnings growth. Management plans to provide more detail on these initiatives at a virtual investor day later this month.
Many of these moves sound like positive steps. However, Bed Bath & Beyond stock is now priced as if investors are certain that the company's turnaround will succeed. There are far too many potential pitfalls to be that confident. The company is finally on the right track, but Bed Bath & Beyond stock doesn't offer enough upside at its current price relative to the risk that management's turnaround plans will ultimately falter.