Margins Remain A Concern For Bed Bath & Beyond Despite EPS Beat

Bed Bath & Beyond‘s (NASDAQ:BBBY) shares rose by more than 7% after it reported its Q2 fiscal 2014 EPS at $1.17, marginally ahead of the consensus estimate of $1.14. Although the retailer’s profits declined by 10% year-over-year, its earnings per share increased by a penny from $1.16 due to an 11% decline in outstanding shares. Bed Bath & Beyond’s overall revenues increased by a healthy 4.3% driven by the improving housing market, while analysts polled by Thomson Reuters expected the growth to be around 2.5%. Although the company’s results were much better than expected, the decline in its profits is still a concern. Driven by weaker gross margins and higher expenses, Bed Bath & Beyond’s profits have fallen for the third consecutive quarter. In Q4 fiscal 2013 and Q1 fiscal 2014, the retailer’s profits declined by 11% and 25%, respectively.

With the prevailing economic uncertainty, coupon redemption at Bed Bath & Beyond has gone up, which has strained its margins. The company’s gross margins shrunk to 38.5% in Q2 from 39.4% a year earlier, as coupon redemption and the average coupon amount went up. ^[1] Although Bed Bath & Beyond stated that its free shipping threshold was partially responsible for its margin decline, we believe the impact of higher coupon usage was also severe. Comparing the company’s gross margins in the last two quarters (both felt the negative impact of free shipping), margins in Q2 were 30 basis points below what they were in Q1. Such a decline within a quarter indicates that buyers may be increasingly relying on discount coupons to shop at Bed Bath & Beyond. To continue driving store traffic amid a mixed retail environment, the company may have to keep relying on attractive deals and discounts, which would keep its gross margins under pressure in the foreseeable future. To improve its profits, Bed Bath & Beyond will have to find a way to reduce its costs, which may be difficult given that it is looking to expand its omni-channel portfolio.

Our price estimate for Bed Bath & Beyond stands at $ 77, implying a premium of more than 20% to the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Bed Bath & Beyond

While shopping for home furnishing products, buyers usually prefer physical stores where they can better analyze the design and quality of available goods. This is the reason why Bed Bath & Beyond hasn’t been too concerned about expanding its e-commerce platform. However, with soaring Internet penetration, the proliferation of smartphones and tablets, and expansion of Amazon‘s (NASDAQ:AMZN) product portfolio, buyers are shopping online for many consumer goods. In response, Bed Bath & Beyond elevated its focus on its e-commerce business a couple of years back and it is now investing heavily towards the development of its omni-channel platform.

Since the online business isn’t particularly big for many retailers, they are now looking to leverage customers’ online shopping interest to enhance store sales. According to a survey conducted by Retail Systems Research (RSR) in June 2013, around 84% of the retailers polled worldwide believed that creating a consistent customer experience across channels was very important. Moreover, multichannel shoppers have a tendency to spend more than regular shoppers as they have access to a wider product range and additional discounts. Therefore, investing in omni-channel retailing is essential for U.S. retailers, including Bed Bath & Beyond.

Bed Bath & Beyond believes that providing a deeper set of merchandise in an omni-channel environment, combined with compelling customer service, will help it gain market share in the future. For this purpose, the retailer is adding additional functions to its relaunched websites for Bed Bath & Beyond and buybuy Baby. It is also upgrading its mobile websites and apps along with network enhancement in stores. Alongside, Bed Bath & Beyond is developing IT analytics, and marketing and e-commerce groups. The company has completed the construction of its IT data center in North Carolina and is in the process of staffing and equipping the facility. In addition, it is planning to open another distribution facility for its direct-to-consumer and store fulfillment. Given that Bed Bath & Beyond is at a nascent stage in its omni-channel quest, initiatives such as the ones mentioned above will cost significantly in the near term. This could keep its profits under pressure going forward.

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1. Bed Bath & Beyond’s Q2 fiscal 2014 earnings transcript, Sept 23 2014 [↩]