Bed Bath & Beyond's (BBBY 8.60%) stock surged to $52.89 per share, its highest level in more than five years, on Jan. 27. But that rally, which briefly gave it a year-to-date gain of 193%, wasn't sparked by any sudden improvements in the underlying business.
Instead, Bed Bath & Beyond was lifted along with GameStop and other heavily shorted stocks in a historic short squeeze. But shortly afterwards, Bed Bath & Beyond's stock dropped to about $25 -- although it remains up approximately 40% for the year. Can it maintain those gains through the rest of the year?
Is the short squeeze over?
Bed Bath & Beyond's short interest stood at 82% in mid-January. That ratio, which is updated every two weeks, hasn't been updated as of this writing -- but it likely plummeted after the stock more than doubled in the week before Jan. 27.
Therefore, future short squeezes probably won't propel the stock back to $50 anytime soon. Instead, investors should see if Bed Bath & Beyond's fundamentals actually justify its current price.
The story thus far
Bed Bath & Beyond is often considered a victim of the retail apocalypse. Amazon, Walmart, and other competitors pulled away its shoppers, it neglected its cluttered stores, it didn't invest enough money into its e-commerce platform, and it crushed its own margins with desperate coupons and promotions.
Instead of improving its core business, it bought smaller chains like buybuy BABY, Chef Central, Christmas Tree Shops, and Cost Plus World Market to temporarily boost its revenue. However, most of those acquisitions failed to generate sustainable comparable store sales growth.
Activist investors finally ousted the retailer's longtime CEO Steven Temares in 2019, and brought in Target's former chief merchandising officer Mark Tritton as its new leader.
Tritton promptly fired most of the company's executives, brought in new leaders, and divested the company's real estate and non-core banners to generate fresh cash. He then plowed that cash into improving its supply chain, expanding its e-commerce platform, and renovating its stores. Those efforts were just starting to bear fruit when the pandemic struck.
Reviewing the fundamentals
Bed Bath & Beyond's revenue declined 7% in fiscal 2019, which ended last February, as its net loss widened. Its revenue fell another 18% year-over-year to $6.6 billion in the first nine months of 2020, but its net loss narrowed from $548 million to $160 million as it cut costs, divested some assets, and stabilized its gross margins.
Those numbers may seem weak, but they mask some fundamental improvements. Bed Bath & Beyond's sales plunged in the first quarter of 2020 as it closed its stores amid the pandemic, but its comps improved 6% in the second quarter -- which marked its first quarter of comps growth since the fourth quarter of 2016.
Its comps rose another 2% in the third quarter, led by 5% growth at its four core banners: Bed Bath & Beyond, buybuy BABY, Harmon Face Values, and Decorist. Over the past year, it divested five other non-core banners, including Christmas Tree Shops and One Kings Lane, to raise more than $600 million. It also agreed to sell Cost Plus World Market, which dragged down its comps growth in the third quarter, in December.
Tritton's focus on online sales paid off: The company's digital sales rose 82% in the first quarter, 89% in the second quarter, and 77% in the third quarter. It also gained over seven million new online shoppers throughout the first three quarters as the pandemic forced more people to shop online.
Its adjusted gross margin expanded year-over-year in the second and third quarters, thanks to tighter controls over its markdowns and coupons, stronger sales in higher-margin categories like bedding and bath products, and lower distribution and fulfillment expenses. It also reiterated its goal of reducing its inventories, which already declined 20% to $2.1 billion in 2019, by another $1 billion by 2021.
But can this fragile recovery continue?
Mark Tritton's team has made significant progress in a short time, but Bed Bath & Beyond's recovery remains fragile. It didn't provide any specific guidance last quarter, and analysts still expect its revenue to drop 17% for the full year, mainly due to its big divestments, as its bottom line stays in the red.
In fiscal 2021, they expect its revenue to dip another 12% as it returns to profitability. Based on its current price of $25, its stock trades at a reasonable 28 times forward earnings.
However, investors shouldn't put too much faith in analysts' estimates right now, since the pandemic isn't over and Bed Bath & Beyond still faces intense competition from Amazon, Walmart, Target, IKEA, and other retailers.
So where will this stock be in a year?
If Bed Bath & Beyond can maintain positive comps growth at its core banners while maintaining stable gross margins, I believe its stock can maintain a forward P/E ratio of over 20.
But if it stumbles, I expect the stock to be cut in half. In other words, the risks still outweigh the rewards up here, and it could be prudent to take some profits off the table.