Bed Bath & Beyond Inc.

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1 January 21, 2015 Bed Bath & Beyond Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 11/23/2009 Current Price (01/20/15) $73.31 Target Price $ Week High $ Week Low $56.70 One-Year Return (%) Beta 0.88 Average Daily Volume (sh) 3,072,382 Shares Outstanding (mil) 186 Market Capitalization ($mil) $13,606 Short Interest Ratio (days) 6.92 Institutional Ownership (%) 95 Insider Ownership (%) 4 (BBBY-NASDAQ) SUMMARY Bed Bath & Beyond posted solid third-quarter fiscal 2014 results, wherein both sales and earnings increased year over year. Further, the company raised its earnings forecast for fiscal We are impressed by the company s focus on strategic initiatives, including store expansion, enhancement of ecommerce capabilities and improvisation of customer services. Further, the company s debt-free balance sheet and cash flow generating capacity provides increased visibility to drive future growth. Also, looking at the improving housing market, we expect the company s sales to grow at an impressive pace. However, we remain concerned regarding the company s margins, which have been negatively impacted by a rise in coupon expenses and an increase in net direct-to-customer shipping expense. Given the pros and cons, we maintain our Neutral stance on the stock. Risk Level * Low, Type of Stock Large-Growth Industry Retail-Misc/Div Zacks Industry Rank * 77 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (May) (Aug) (Nov) (Feb) (Feb) Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 9.8 Earnings Per Share (%) 17.3 Dividend (%) N/A using TTM EPS 15.0 using 2014 Estimate 14.5 using 2015 Estimate 13.4 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page ,218 A 2,593 A 2,702 A 3,401 A 10,915 A ,612 A 2,824 A 2,865 A 3,203 A 11,504 A ,657 A 2,945 A 2,943 A 3,369 E 11,914 E ,776 E 3,061 E 3,066 E 3,465 E 12,368 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (May) (Aug) (Nov) (Feb) (Feb) 2012 $0.89 A $0.98 A $1.03 A $1.68 A $4.56 A 2013 $0.92 A $1.16 A $1.12 A $1.60 A $4.78 A 2014 $0.93 A $1.17 A $1.19 A $1.75 E $5.04 E 2015 $1.01 E $1.29 E $1.25 E $1.91 E $5.46 E Projected EPS Growth - Next 5 Years % 7 (Note: Qtly. figures may not add up to annuals due to rounding off.) 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Bed Bath & Beyond Inc. is a leading operator of specialty retail stores in the U.S. and Canada. The company offers merchandise through Bed Bath & Beyond, Harmon, Christmas Tree Shops (CTS), andthat!, World Market, Cost Plus World Market, World Market Stores and buybuy BABY stores. Bed Bath s stores primarily span across 20,000 50,000 square feet on an average, while some stores even exceed an area of 80,000 square feet. The company provides a wide assortment of everyday low price products, primarily including domestic merchandise (such as bed linens, bath accessories, and kitchen textiles) and home furnishings (such as cookware, dinnerware, glassware and basic house ware). Bed Bath s product portfolio also includes food, giftware, health and beauty care items along with infant and toddler merchandise. As of Nov 29, 2014, the company operated 1,019 Bed Bath & Beyond stores in all 50 states, the District of Columbia, Puerto Rico and Canada; 270 World Market or Cost Plus World Market stores; 78 Christmas Tree Shop or andthat! stores; 93 buybuy BABY stores and 50 stores under the names of Harmon or Harmon Face Values, thereby bringing the total store count to 1,510. Additionally, in a joint venture, Bed Bath & Beyond operates 5 stores in Mexico City under its namesake brand. REASONS TO BUY Competitive Advantage through Efficient Merchandising Strategies: Bed Bath is a leading operator of domestic merchandise and home furnishing stores in the U.S. A strong countrywide network of more than 1,100 stores coupled with its strategic efforts to align merchandise according to regional climate and demographics offer a strong competitive advantage while strengthening its wellestablished position in the market. Moreover, the company s strategy of avoiding dependence on a single supplier helps it enjoy a superior bargaining power over its peers. The company has a total of nearly 5,500 suppliers, both domestic and international, with the largest supplier accounting for only 5% of total supplies. Store Initiatives to Attract Customers: Bed Bath & Beyond is in the process of strategically expanding its store count, while increasing the productivity of its existing stores by adjusting the breadth and depth of its merchandise offerings to suit customer preferences. The company is on track to complete its targeted 22 store openings across all concepts in fiscal In the long run, the company expects to operate over 1,300 Bed Bath & Beyond stores across the U.S. and Canada and also plans to expand other concepts from coast to coast. Moreover, the company remains focused on expanding, renovating and relocating stores to adapt to the changing market conditions. We believe that these initiatives will go a long way in retaining existing customers, while attracting new ones. Capital Initiatives: The company continually reviews and prioritizes its capital needs, making the right investments to help position itself for long-term success. The company anticipates capital expenditure of about $350 million in fiscal 2014, mainly on new stores and refurbishment of existing stores, enhancement of information technology and other important future projects. Looking ahead, the major information technology projects in hand include upgrade of mobile sites and apps, enhancement of network communications in stores, implementation of point-of-sale improvements and building, equipping and staffing its new IT Data Center to support ongoing technology initiatives. Healthy Balance Sheet & Strong Cash Flows Driving the Growth: Bed Bath & Beyond had a debt-free balance sheet as along with cash and equivalents of $1,043.8 million at the end of thirdquarter fiscal 2014, which provides it the financial flexibility to drive future growth. The company s ability to generate a strong operating cash flow has helped in the execution of its long-term strategies such as store expansion, enhancement of product and brand offerings as well as building operational Equity Research BBBY Page 2

3 infrastructure. In December, the company completed its $1.1 billion accelerated share repurchase program announced in Jul At the quarter-end, Bed Bath & Beyond had nearly $1.8 billion remaining under its ongoing share repurchase program which it intends to complete by fiscal Notably, the company has returned nearly 90% of its cash flows to shareholders through share repurchases in the past 2 years. REASONS TO SELL Margins Continue to be Under Pressure: The company s margins remained soft during the third quarter due to a rise in coupon expenses stemming from higher redemptions and an increase in net direct-to-customer shipping expense, partly offset by a decline in average coupon amount. Going forward, we expect this weakness to continue due to persistence of the above factors. Moreover, the company has hinted at a rise in selling, general and administrative expenses for both fourth quarter and fiscal 2014 due to an increase in technology and depreciation expenses resulting from investments. Therefore, we expect the company s bottom-line results to bear the brunt of weak margins. Macroeconomic Headwinds: The company s customers remain sensitive to macroeconomic factors including increase in fuel and energy costs, credit availability, unemployment levels and high household debt levels, which may negatively impact their discretionary spending, in turn affecting the company s growth and profitability. Seasonal Risks: Bed Bath s business is seasonal in nature and typically generates stronger results in the second and fourth quarters. As a result, the company is exposed to significant risks if the seasons fail to deliver favorably. RECENT NEWS Bed Bath & Beyond Q3 Sales Miss, Ups FY14 Earnings View- Jan 8, 2015 Bed Bath & Beyond's third-quarter fiscal 2014 earnings of $1.19 per share were in line with the Zacks Consensus Estimate of $1.19 per share and within the company s guidance range of $1.17 $1.21 per share. Moreover, bottom-line results improved 6.3% from $1.12 per share reported in the prior-year quarter. The company s net sales of $2,943 million for the quarter registered a year-over-year increase of 2.7%. However, it fell short of the Zacks Consensus Estimate of $2,968 million and the company s own guidance range of 2.8% 3.7%. The company's top-line improved year-over-year due an increase in comparable-store sales (comps) and new store openings. Bed Bath & Beyond revealed that 60% of the top-line growth was contributed by rise in comps while the remaining 40% was contributed by new store openings. Comps grew 1.7% for the quarter compared with a 1.3% increase reported last year, but were below the company's forecast of 2% 3%. Comps growth from last year mainly reflected an increase in average transaction amount as well as the number of transactions. The company stated that its comps will now include results from the Cost Plus World Market business, which were absent through the first half of fiscal Gross profit improved to $1,129 million, a marginal rise of 0.7% from the comparable year-ago period. However, gross profit margin for the quarter contracted 80 basis points (bps) to 38.4% from 39.2% in Equity Research BBBY Page 3

4 third-quarter fiscal Margins suffered a downside mainly due to a rise in coupon expenses stemming from higher redemptions and an increase in net direct-to-customer shipping expense, partly offset by a decline in average coupon amount. Selling, general and administrative (SG&A) expenses increased 3.9% year over year to $776.3 million. As a percentage of sales, it rose 30 bps to 26.4% due to higher technology expenses and related depreciation as well as increased advertising costs. Consequently, operating margin contracted about 110 bps to 12% from the prior-year quarter. Operating profit, in dollar terms, decreased 5.8% to $352.7 million. Financial Position Bed Bath & Beyond ended the quarter with cash and cash equivalents of $1,043.8 million compared with $471.1 million at the end of third-quarter fiscal Shareholders' equity, as of Nov 29, 2014, stood at $3,189.3 million versus $4,129.8 million, as of Nov 30, Further, during the nine months of the fiscal year, the company generated cash flow of $504.2 million from operating activities while deploying $231 million toward capital expenditures. Looking ahead, Bed Bath & Beyond plans to incur capital expenditure of approximately $350 million in fiscal In December, the company completed its $1.1 billion accelerated share repurchase program that went live in Jul Apart from this, as of the third quarter-end, Bed Bath & Beyond had nearly $1.8 billion remaining under its ongoing share repurchase program, which it intends to complete by fiscal Store Update In the third quarter, Bed Bath & Beyond inaugurated four Bed Bath & Beyond stores, one buybuy BABY store and one Cost Plus World Market store, while shutting down two Bed Bath & Beyond stores. Moreover, on Dec 5, the company has opened its first buybuy BABY store in Edmonton, Canada. As of Nov 29, 2014, the company operated 1,019 Bed Bath & Beyond stores in all 50 US states, the District of Columbia, Puerto Rico and Canada; 270 World Market or Cost Plus World Market stores; 78 Christmas Tree Shop or andthat! stores; 93 buybuy BABY stores and 50 stores under the names Harmon or Harmon Face Values, thereby bringing the total store count to 1,510. Additionally, in a joint venture, Bed Bath & Beyond operates 5 stores in Mexico City under its namesake brand. As a result, the company s net store space as of Nov 29, 2014 was 43 million square feet, reflecting a growth of 1.1% year over year. Including the stores opened to-date, the company remains on track to complete its targeted 22 store openings in fiscal Outlook Based on its year-to-date performance and its expectations for the rest of fourth quarter, Bed Bath & Beyond has slightly adjusted its sales guidance for the fourth quarter and fiscal Meanwhile, the company retained its forecast for fourth-quarter earnings and raised its projections for the same for fiscal Equity Research BBBY Page 4

5 The company now anticipates sales growth in the range of 4.4% 5.4% for the fourth quarter compared with a 4.5% 5.5% increase projected earlier. Moreover, it now expects fiscal 2014 sales to grow between 3.4% and 3.6% versus 3.4% 3.9% growth expected earlier. The company continues to expect comps growth for the fourth quarter in the range of 4% 5%, while it initiated its full year comps guidance, anticipating an increase in the 2.4% 2.7% range. The company projects gross margin to deleverage slightly in the fourth quarter and deleverage in fiscal 2014, primarily due to higher coupon expense and net direct-to-customer shipping expense. SG&A expenses are projected to slightly increase in both fourth quarter and fiscal 2014, due to a rise in technology and depreciation expenses resulting from ongoing investments. Depreciation expense for the fiscal is expected to increase about $240 million. Interest expense for the fourth quarter is projected at $20.3 million, while the tax provision for the quarter stands in the mid to high-30s percentage range. Diluted shares outstanding are expected to be nearly 178 million for the fourth quarter and 189 million for the full-year. Based on these assumptions, the company reiterated its fourth-quarter earnings per share guidance in the range of $1.78 $1.83. However, it raised its earnings per share forecast for fiscal 2014 to $5.05 $5.09 compared with $5.00 $5.08 projected earlier. VALUATION Bed Bath s current trailing 12-month earnings multiple is 15.0x compared with 25.1x for the industry average and 18.6x for the S&P 500. Over the last five years, Bed Bath s shares have traded in the range of 11.9x to 20.0x trailing 12-month earnings. Based on forward earnings estimate, the stock is trading at a discount to the industry average. Our long-term Neutral recommendation on the stock indicates that it would perform in line with the broader market. Our target price of $77.00, 14.1x 2015 EPS, reflects this view. Equity Research BBBY Page 5

6 Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Bed Bath & Beyond Inc. (BBBY) Industry Average S&P CST Brands, Inc. (CST) Office Depot, Inc. (ODP) N/A N/A 42.8 PetSmart, Inc. (PETM) DICK S Sporting Goods Inc. (DKS) TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Bed Bath & Beyond Inc. (BBBY) Industry Average S&P N/A 2.0 N/A Equity Research BBBY Page 6

7 Earnings Surprise and Estimate Revision History Equity Research BBBY Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of BBBY. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform %, Neutral %, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research BBBY Page 8