Bed Bath & Beyond Earnings Preview: Profits Will Be Under Pressure

Home goods giant, Bed Bath & Beyond (NASDAQ:BBBY) is slated to release its Q2 fiscal 2014 earnings on September 23rd after market close, and we expect its profits to remain under pressure once again. While the company has posted steady revenue growth for the past couple of years, its profits have declined substantially during the last two quarters due to increased coupon redemption and higher investments in technology. Bed Bath & Beyond’s profits fell by 11% year over year in the fourth quarter of fiscal 2013, and 25% year over year in the first quarter of the current fiscal year. For the second quarter, analysts expect the retailer’s earnings per share to come in at $1.14, a decline of 2% year over year. It may be worth noting that Bed Bath & Beyond failed to meet the consensus EPS estimate in Q1, which might happen again in the second quarter.

After its dismal first quarter results, Bed Bath & Beyond guided its second quarter EPS at $1.08-$1.16, below analysts’ estimates of $1.20. The company cited slow revenue growth, lower gross margins and higher operating expenses as the primary reasons for its low profitability. While the slowing housing market and online shift is making Bed Bath & Beyond’s revenue growth strenuous, increased coupon redemption is weighing on its gross margins. Analysts polled by Thomson Reuters are expecting the company’s revenues to increase by just 2.5% in the second quarter.

During the first quarter, the retailer’s gross margins shrunk by 70 basis points driven by increased coupon redemption rate and a higher average coupon amount. The retailer’s SG&A rate also rose as it invested heavily in mobile and online technologies, as part of its strategy to strengthen its online business. These factors will most likely weigh on Bed Bath & Beyond’s profits in the second quarter as well.

Our price estimate for Bed Bath & Beyond stands at $ 77, implying a premium of more than 20% to the market price.

See our complete analysis for Bed Bath & Beyond

Falling Foot Traffic will Weigh on Revenue Growth

Due to the increased proliferation of smartphones and tablets, and the convenience of online shopping, U.S. buyers have been making more purchases online. Subsequently, they are visiting fewer stores, which is a concern for a number of retailers who do not have a sizable online presence. As per the data compiled by ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year over year in almost all the months of the past two years. This decline appears to be a permanent one given that internet penetration is high at 87% and buyers are now a lot more comfortable with making online transactions. Hence, the e-commerce channel is serving as a reliable medium for shopping. While this may be a healthy trend for the overall industry, big retailers such as Costco (NASDAQ:COST), Wal-Mart (NYSE:WMT) and Bed Bath & Beyond, who rely on store sales for a bulk of their revenues, aren’t enjoying it.

Store traffic across the U.S. retail market has fallen regularly during the past couple of years and we see no reason why it won’t continue in the future. Several retailers have ramped up their investments in omni-channel retailing in response to the online shift. While Bed Bath & Beyond is also making significant strides on this front, it will be a while before it sees any measurable results. Hence, the retailer’s second quarter results will suffer more from a fall in foot traffic, than they will gain from incremental online sales.

Increased Coupon Redemption and Other Factors will Push Gross Margins Down

During the first quarter of fiscal 2014, Bed Bath & Beyond’s gross profit margin declined from 39.5% to 38.8% primarily due to an increase in coupon expenses, which resulted from an increase in redemption and a higher average coupon amount. In addition, increased customer shipping expenses, due to the retailer’s free shipping threshold and a shift in sales mix to low margin categories, also weighed on its margins. Higher coupon redemption has been a drag on Bed Bath & Beyond’s margins for some time now, and we expect it to remain this way in the second quarter as well on account of weak consumer spending. Due to sluggish U.S. economic growth and higher home prices, U.S. shoppers might look to reduce their budget for home decor and improvement products. Subsequently, they will look for cheaper products at Bed Bath & Beyond and other home improvement retailers, which will continue to facilitate a shift in sales mix to low margin products. Although the impact of added expenses due to free shipping will subside gradually, it will put pressure on Bed Bath & Beyond’s gross margins in Q2 fiscal 2014.

Higher Investments will add to Operating Expenses

During the previous quarter, Bed Bath & Beyond’s operating expenses increased at a faster rate than its sales growth, resulting in a 30 basis points rise in its SG&A expense rate. Driven by increased investments in mobile technologies, the company’s operating expenses increased by 2.9%, which drove its SG&A expenses as percentage of revenues from 27.2% in Q1 fiscal 2013 to 27.5% in the recently concluded quarter. Bed Bath & Beyond has been investing heavily in new technologies and infrastructure to revamp its online platform in the wake of growing threat from Amazon (NASDAQ:AMZN).

With growing competition from online retailers and gradual customer shift to the online channel, the home goods retailer is investing more in its e-commerce business to add new functionality and assortments to its online and mobile websites. It is accelerating the deployment of systems and equipment to take advantage of new technologies. Alongside, the company is strengthening its IT, analytics, marketing and e-commerce groups, and developing a platform where products ordered online can be shipped directly from stores or vendors’ warehouses. Bed Bath & Beyond is also opening an additional distribution facility to support the needs of its online and store business. The company stated in its Q1 earnings call that while these investments are necessary, they will weigh on its profits in the near term. Hence, Bed Bath & Beyond’s second quarter results will feel the negative impact of these investments.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)