Arrrgghhh! I hate it when I miss a screaming bargain opportunity! But I am going to blame my misfortune on Barron's. You see, it should have written its article (asking if home decor retailer Bed Bath & Beyond (NASDAQ:BBBY) was a bargain) about six months ago. All is not completely lost, though, because even at today's price, I think the stock still represents a decent bargain (and is certainly worthy of your vote in this episode of Dueling Fools).
I am going to lay out the Bull case for Bed Bath & Beyond in old-school fashion by showing you how the right competitive position coupled with the right capabilities can lead to an advantage. So without further ado, let's kick it old-school.
Competitive position
Unlike competitors Pier 1 (NYSE:PIR) and Cost Plus (NASDAQ:CPWM), Bed Bath & Beyond sells more branded merchandise that appeals to a mass audience. Those other companies may have some cool stuff, but they appeal to a smaller group of customers, and had more trouble adjusting when tastes changed.
Operating performance
When a company has a good competitive position and the right supporting capabilities (in this case, merchandising, marketing, and logistics), it can outperform even the toughest competition. And that's exactly what Bed Bath & Beyond has done against its biggest rival, Williams-Sonoma (NYSE:WSM), whose retail unit accounts for about 60% of sales, while the direct-to-customer unit accounts for about 40% of sales.
Sales/Sq. Ft.
|
YE 2002 |
YE 2003 |
YE 2004 |
YE 2005 |
YE 2006 | |
|---|---|---|---|---|---|
|
Bed Bath & Beyond |
$228 |
$224 |
$219 |
$210 |
$199 |
|
Williams-Sonoma |
$403 |
$390 |
$390 |
$382 |
$389 |
Inventory Turns
|
YE 2002 |
YE 2003 |
YE 2004 |
YE 2005 |
YE 2006 | |
|---|---|---|---|---|---|
|
Bed Bath & Beyond |
2.5 |
2.6 |
2.7 |
2.7 |
2.7 |
|
Williams-Sonoma |
4.9 |
4.9 |
4.5 |
4.4 |
4.3 |
Operating Margins
|
YE 2002 |
YE 2003 |
YE 2004 |
YE 2005 |
YE 2006 | |
|---|---|---|---|---|---|
|
Bed Bath & Beyond |
11.8% |
13.1% |
14.3% |
15.4% |
15.6% |
|
Williams-Sonoma |
6.3% |
8.9% |
9.3% |
9.9% |
10.2% |
Given the numbers above, I bet you are wondering how I can say Bed Bath & Beyond is outperforming Williams-Sonoma. After all, Williams-Sonoma stores are more productive in terms of its sales/sq. ft. and inventory turns, which include its catalog business.
That's why I included operating margins with the other two metrics. There is a cost associated with where Williams-Sonoma has positioned itself (a multi-channel retailer with higher-priced products as well as furniture) and those costs translate into lower operating margins. Bed Bath & Beyond has taken a different strategy and supported it with capabilities that help it earn attractive margins.
The real litmus test
Is Bed Bath & Beyond's advantage sustainable? If it is, we should be able to see it by comparing returns on invested capital. From the table below, we see why Bed Bath & Beyond has an advantage over Williams-Sonoma, even when accounting for operating leases, and is the leader in the home decor space.
Table of Returns on Invested Capital
|
YE 2002 |
YE 2003 |
YE 2004 |
YE 2005 |
YE 2006 | |
|---|---|---|---|---|---|
|
Bed Bath & Beyond |
15.5% |
17.1% |
16.6% |
16.3% |
16.9% |
|
Williams-Sonoma |
10.5% |
13.3% |
13.7% |
13.8% |
14.4% |
Clearly, both companies are doing very well for themselves and creating value for shareholders. But Bed Bath & Beyond outperforms powerhouse Williams-Sonoma by sticking to its strategy of providing everyday home decor products that have lower prices and mass appeal. And Bed Bath & Beyond certainly outperforms other competitors like Kirkland's (NASDAQ:KIRK) and Restoration Hardware (NASDAQ:RSTO), which are both considerably smaller. Oh wait, there's another advantage: scale.
Valuation
Clearly Bed Bath & Beyond is a great company. (In fact, you could argue that Williams-Sonoma is great, too, but that's a Duel for another day.) But great companies don't always make great investments. You have to pay the right price. And while the right price was clearly about six months ago, today's price is pretty good, too.
At $42 per share, the expectations built into the cash flows (adjusted for growth capital expenditures) is 9% growth for the next 5 years, 5% growth for the 5 years after that, and 3% ad infinitum. Those expectations are for a 10% return on investment. And since I think Bed Bath & Beyond, given its competitive advantage and ability to generate great ROIC, can do better than that, I would expect the stock to outperform the market even at these price levels.
The Foolish bottom line
How can you not vote with the Bull here? We have a great company trading at a good price with conservative expectations built into the stock price. No wonder so many value investors gobbled it up in the $30s.
For more on Bed Bath & Beyond, check out:
- Slower Bathing at Bed Bath & Beyond
- Bed Bath & Beyond Comprehension
- Fool on Call: Bed Bath & Beyond's Tub Not Full Yet
You're not quite done yet! To see the Bear argument and the rebuttals, click here. If you've already read everything, cast your vote for the winner here.
Bed Bath & Beyond is both a Stock Advisor and an Inside Value recommendation. Those two newsletters are handily outperforming the market. To see why, click either link to take your free 30-day trial.
Retail editor and Inside Value team member David Meier is ranked 634 out of 20,237 in Motley Fool CAPS and does not own shares in any of the companies mentioned. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
