Just because private equity firm Leonard Green & Partners thinks Bed Bath & Beyond (NASDAQ:BBBY) is a buy doesn't mean you should, too. But if moneyed interests are turning their attention to the home goods retailer, perhaps it is worth looking under the covers.
While Leonard Green established its near-1 million share stake in the company over the course of a year or more, if you look at the P/E firm's investment philosophy, the rationale it uses to take stakes in businesses suggests Bed Bath & Beyond is worth your time and research effort as well.
Searching for profitable growth
Leonard Green has stakes in diverse operations including BJ's Wholesale Club, The Container Store, David's Bridal, and Petco. It says it looks for "cash flow positive businesses that have the ability to grow by at least 50% over a five-year period." Whatever failings and shortcomings Bed Bath & Beyond has -- and they're largely related to factors beyond its control, including a still relatively weak housing market and a consumer who hasn't benefited from the economic recovery -- the retailer generates a lot of cash.
Since 2012 the company has regularly produced in excess of $1.1 billion in operating cash flow, and despite its steady investment in its stores and base Bed Bath & Beyond still generates significant free cash flow, or the money left over after capital expenditures. At the end of fiscal 2014, Bed Bath & Beyond had $855 million in free cash flow.
No one is particularly worried about its cash-producing capabilities. Instead the concerns lie in its growth story beyond increasing the number of stores in operation.
A growing retail footprint
The company currently operates 1,513 stores in all 50 states, the District of Columbia, Puerto Rico, and Canada. It has more than 1,000 namesake stores, 270 Cost Plus stores, almost 100 Buy Buy Baby stores, 78 Christmas Tree Shops, and 50 Harmon or Harmon Face Values stores. It also operates five Bed Bath & Beyonds in Mexico City with two more opening outside the city this year.
Its strong financial position is allowing management to open 30 new stores companywide, a significant number of of which "will be self-developed," meaning Bed Bath & Beyond will be responsible for the cost of construction.
Yet even with all the expansion of its store footprint, net sales at the specialty retailer haven't been particularly robust, growing at just a 4.4% compound rate over the past two years.
New headwinds ahead?
Same-store sales growth, which strips out growth from opening new stores, also remains rather anemic. Bed Bath & Beyond forecasts comps will widen just 2% to 3% this year, a reduction from the 3% growth or better management expected just a few months ago. While that might not seem like much, Bed Bath & Beyond is not getting the same tailwinds it had even last year when comparable sales only grew 2.4%.
Still, much of that copious cash it generates was returned to shareholders in the form of an accelerated $1.1 billion stock buyback. Sure, it took on about $1.5 billion in debt to do so, a big change for a company that has long eschewed carrying virtually any debt on its balance sheet; but with the free cash flow Bed Bath & Beyond produces there's little worry it won't be able to service the debt.
Investors, though, might have preferred the company use some of that cash to pay a dividend instead. Stock buybacks have their uses, but cash in hand is a far more tangible return.
What it means for investors
Bed Bath & Beyond remains a solid business, but one that is buffeted at times by external forces. Currency fluctuations in Canada, for example, continue to undermine its progress and had an unfavorable impact on comparable sales this past quarter. The question is, can the company overcome those headwinds and build on its inner strengths?
It's been plodding along since the end of the recession, with shares doubling since then. With its enterprise value priced at around 14 times its free cash flow, Bed Bath & Beyond might not be a bargain-basement stock, but it still offers an attractive valuation for investors with a long-term investment horizon.
Leonard Green & Partners says it has owned a number of the companies in its portfolio for 10 years or more. That's an appropriate way to look at stock investing, and it wouldn't be surprising to see Bed Bath & Beyond join those businesses as a long-term holding.