Factors That Can Alter Bed, Bath & Beyond’s Valuation By 10% Or More

Bed, Bath & Beyond (NASDAQ:BBBY) has not had the best start to the year 2015. The company has been struggling in light of weak housing recovery as well as intense competition from online retailers such as Amazon (NASDAQ:AMZN). Through fiscal 2015, the company expects a slow increase of 2-3% in comparable sales. Net sales are expected to be 90 basis points above comparable sales for the full year. ^[1] Our price estimate for Bed, Bath & Beyond stands at $70.29 per share, approximately 2% below its current market price. This price estimate incorporates our base case scenario of gradual recovery in the housing market over the forecast period. It also incorporates the expectation that Bed, Bath & Beyond’s investments in omni-channel retailing will achieve scale in the short run.

See our complete analysis for Bed, Bath & Beyond

Alternate Scenario #1: Average Revenue Per Sq. Feet Declines Before Gradually Rising

There are several plausible factors that could result in this scenario. At the forefront is the expectation that a housing recovery will be slower than currently assumed. The housing market, as incorporated in our base case scenario, is expected to see gradual recovery over the period of our forecast, as other macroeconomic factors such as employment pick up pace. However, there is some concern in the current recovery of housing markets. Even as home prices are seeing a rise, new construction continues to remain at recession-level lows of around one million houses. ^[2]

This softness in the housing recovery, despite other macroeconomic factors such as more favorable job creation, could signal a possible recovery in the housing market might falter in the short run. Bed, Bath & Beyond’s key customers are the ones moving into new homes, as they generate higher revenue per customer as opposed to those refurnishing a section of their existing homes. As a result, if the housing recovery wavers in the short run, average revenue per square feet could witness a decline to the 2011 level in the short-run and thereafter gradually rise.

Another factor that could cause the average revenue per square feet to decline in the short-run is a reduction in overall retail spending. In a post-recessionary environment, even as consumers are facing marginal additional savings with lower gas prices, retail spending has continued to remain low. Consumers continue to remain more likely to save than spend in the aftermath of the recent recession. A boost can only be expected when wages also see a significant rise. However, average wage indicators in the U.S. have remained relatively flat this year, and in the scenario that there is no significant growth in wages, retail spending will continue to remain low and contribute to the decline in average revenue per square feet at Bed, Bath & Beyond, as consumers flock to cheaper non-premium alternatives such as Walmart (NYSE: WMT) or Amazon (NASDAQ:AMZN) for their home furnishings needs.

In the scenario that average revenue per sq. feet witnesses a decline before gradually improving, our price estimate for Bed, Bath & Beyond would change to $63.47, a 10% fall to its current valuation.

See our analysis of declining average revenue per sq. feet at Bed, Bath & Beyond

Alternate Scenario #2: Intense Price Competition Drives Margins Lower

The online retail industry has been witnessing growth as it offers lower prices at greater convenience. In a post-recessionary environment, consumers are more inclined to gravitate towards the price leader. In response, Bed, Bath & Beyond has had to launch several initiatives, resulting in higher expenses that are weighing down margins. Some of the initiatives taken up by Bed, Bath & Beyond to keep up with the changing retail environment include increased and more aggressive coupon offerings, a price match policy that allows consumers to pay the same lower price for a product as offered by Amazon and a shift towards lower-margin goods in its sales mix. The most significant initiative however, is that of transitioning to an omni-channel model which has required significant investment in technology. As a result of these initiatives, with a backdrop of a recovering housing market, Bed, Bath & Beyond has witnessed declining margins for the past four years. In our base case, we believe margins will continue to fall in the short-term and then remain flat over the remainder of the forecast period. This is based on the expectation that Bed, Bath & Beyond’s omni-channel model will achieve scale by 2018, and the incremental revenues from the online channel will prevent a further fall in margins. We assume that at the end of the forecast period, margins at Bed, Bath & Beyond will be 38.5%.

Though Bed, Bath & Beyond continues to improve upon its online and mobile platform, key players like Amazon continue to remain significantly ahead of the curve. Amazon has been rolling out new features, such as free two-hour delivery on certain merchandise, making it more attractive to the consumer. ^[3] Many online retailers also directly connect suppliers with the consumer, increasing price competition in the industry. In the face of such competition, Bed, Bath & Beyond will have to continue to invest in its technology to match up to the features offered by its online counterparts, making it harder for its online business to achieve scale in the short-run. The company will also be forced to offer lower prices by increasing coupons and shifting to a low-margin mix of merchandise. Bearing these factors in mind, gross margins could decline to 35% by the end of the forecast period. Other stores operating under the Bed, Bath & Beyond umbrella that have lower brand loyalty could see margins decline even further to 33%. In this scenario, our price estimate for Bed, Bath & Beyond will change to $63.21, more than 10% to our current valuation.

See our analysis for intense price competition driving gross margins lower at Bed, Bath & Beyond

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1. Bed Bath & Beyond Inc Key Developments, April 9th, 2015, Bloomberg Business [↩]
2. United States Housing Starts, Trading Economics [↩]
3. Amazon Prime 1-hour deliveries now available across Manhattan, 17th February, 2015, Mashable [↩]