How Bed Bath & Beyond Progressed Through 2014

Bed Bath & Beyond (NASDAQ:BBBY) is one of the biggest specialty retailers of home furnishings, kitchen, bath and linen products. The company has 1,496 stores across five different brand names in the United States, Puerto Rico and Canada. It primarily caters to consumers looking to furnish or refurnish their homes. Given the nature of the business, Bed Bath & Beyond’s operations are affected by the broader trends in the housing market as well as levels of consumer discretionary spending.

Bed Bath & Beyond started the year on a dim note, growing its sales by just 1.7%  year over year in the first quarter. However, it improved its financial performance subsequently by shifting to omni-channel retailing and offering discounts on its products. The recovery in the U.S. housing market remained weak throughout the year, and competition from online retailers such as Amazon (NASDAQ:AMZN) intensified. Overall, the first three quarters of the year were challenging for the company. It managed to grow its revenues by 3% year over year for the nine months ending in November 2014. For the fourth quarter (ended February 28th), we believe that any increase in net sales due to omni-channel retailing and heavy markdowns was likely offset by a fall in foot-traffic due to extreme weather conditions and the weak housing market in the U.S. As a result, revenue growth probably continued to remain at current levels.

Our price estimate for Bed Bath & Beyond stands at $79.26, which is higher than the current market price.

See our complete analysis for Bed Bath & Beyond

Weak Housing Recovery Impacted Bed Bath & Beyond’s Sales

The housing market in the U.S. continues to show frail signs of recovery. The government has been trying to boost home sales in the U.S. by keeping interest rates low. However, many consumers are reluctant to invest in a home, given the relatively weak recovery in the economy.

The growth in housing starts, which depict the number of new residential construction projects undertaken, is also seeing a slowdown. The number of new residential construction projects was above 2 million during the housing bubble before the recession. However, it reduced substantially in the subsequent years reaching below 900,000, as of February 2015. ^[1] This makes it apparent that fewer people are now investing in building new homes in the U.S., and we don’t expect any meaningful recovery anytime soon.

Revenues of home furnishing retailers such as Bed Bath & Beyond are highly tied to new home sales. The decline in the number of new homes sold has resulted in a fall in number of potential customers for Bed Bath & Beyond. This has translated to a slower revenue growth, especially when compared to the pre-recession levels. While the retailer’s net sales saw an increase of approximately 14% in 2007, the figure dropped to a mere 5% in 2014.

Uncertain Consumer Discretionary Spending Played A Notable Role

Although consumer discretionary spending is improving in the U.S., the rate of recovery remains slow. The impact was clearly visible on Bed Bath & Beyond’s performance over the first three quarters of the 2014. However, the outlook is promising as we expect the recent drop in gasoline prices to increase disposable income and stimulate consumer spending.

Gasoline prices started dipping in the second half of 2014 due to excess global supply The price per gallon of gasoline has moved from approximately $3.78 in June 2013 to $2.40 in February 2015. ^[2] At current levels, gasoline prices are at a six-year low and while there might be some bounce back in the short to medium term with recovery in global crude oil prices, we do not expect gasoline prices to retest their 2013 levels anytime soon.

Consumer confidence in the U.S. started improving in 2014, and reached pre-recession levels in the first three months of 2015. Although the extreme cold weather in the country has negatively impacted consumer confidence over the past couple of months due to expensive heating bills, the figure still remains at very healthy levels. ^[3] The overall increase in consumer confidence was in line with the fall of unemployment rates in the United States. The unemployment rate decreased from 6.6% in January 2014 to 5.5% in February 2015, and we expect it to continue on this trajectory in the near term.  ((Labor Force Statistics from the Current Population Survey, U.S. Bureau of Labor Statistics))

The drop in gasoline prices coupled with a fall in unemployment rates in the U.S. and rise in overall consumer confidence is expected to encourage consumer retail spending. We believe that this could result in increased spending at Bed Bath & Beyond’s stores and websites. However, there is no certainty that the expected increase in discretionary spending will encourage consumers to spend at premium outlets such as Bed, Bath & Beyond. In the post-recession environment, consumers are spending more cautiously. As a result, Bed Bath & Beyond has resorted to heavy discounting and is also pushing to improve its web-presence to compete with online retailers such as Amazon and Overstock, who offer products at highly competitive prices.

Bed Bath & Beyond’s Shift in Operational Model

Bed Bath & Beyond started 2014 on a weak note as net sales for the first quarter grew just 1.7% year over year. Interestingly, only 24% of this growth was attributable to comparable sales growth. ^[4]

The lower contribution of comparable sales to overall net sales shows a clear weakness in the company’s existing business. Considering the industry-wide decline in foot traffic, cautious consumer spending and increasing online shopping options, the weakness in comparable sales growth at Bed Bath & Beyond may continue.In subsequent quarters, Bed Bath & Beyond increased its online and mobile sales offerings. It deployed several omni-channel initiatives and aggressively pushed coupons offerings. Consequently, net sales in the second quarter saw a 4% year-on-year growth. Comparable sales were also up 3.4% and over 50% of this increase came from online sales and mobile channels. However, the increase in markdowns, along with an increase in coupon redemptions weighed heavily on its profitability, driving gross profit margins approximately 100 basis points lower on a year-on-year basis. ^[5] Bed Bath & Beyond also increased its investment in technology to compete with online retailers, which drove up its operating costs in the second quarter. During this phase, the company worked on revamping its existing Bed Bath & Beyond and buy buy BABY websites to offer a more seamless shopping experience to its customers. These websites were launched in the third quarter of the year.

Seasonally, the third quarter typically shows lower year-on-year growth in net sales compared to the second quarter. The second quarter includes back-to-school shopping which usually drives up sales significantly. In the Q3 2014, net sales saw a 3% year-on-year rise. About 40% of comparable sales were attributable to online and mobile channels as consumers adapted to the new re-platformed websites. ^[6] Costs related to technology continued to drive margins lower in this quarter. However, such investments are inevitable to survive in changing retail environment and remain competitive.

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1. United States Housing Starts, Trading Economics [↩]
2. Gasoline and Diesel Fuel Update, U.S. Energy Information Administration [↩]
3. Home-Heating Bills Put U.S. Consumers in Sour Mood: Economy, Bloomberg Business [↩]
4. Bed Bath & Beyond’s (BBBY) CEO Steven Temares on Q1 2014 Results – Earnings Call Transcript, SeekingAlpha [↩]
5. Bed Bath & Beyond’s (BBBY) CEO Steven Temares on Q2 2014 Results – Earnings CallTranscript, SeekingAlpha [↩]
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