It’s one of the more intriguing questions on Wall Street lately: Is beaten-up general merchandise retailer Bed Bath & Beyond (NASDAQ:BBBY) in the early stages of a huge turnaround? BBBY stock is down more than 55% in the past two years compared to a 23% increase in the S&P 500 index in that period.
Ask activist investment firms Legion Partners, Macellum Advisors and Ancora Advisors — all of which have recently built sizable stakes in BBBY stock — and their answer is a resounding “yes.” They argue that Bed Bath & Beyond is a valuable retail operation which has been mismanaged over the past several years, and that under the right management, things could turn around quickly, which would lead to a huge pop in BBBY stock.
But, look at the fourth-quarter numbers that Bed Bath & Beyond reported on Wednesday, and the answer is a resounding “no.” Comparable sales continue to drop. Gross margins are still falling. Opex rates are still rising. Profits are still eroding. In short, nothing about the current numbers implies that BBBY stock is even close to any type of turnaround.
Where do I sit on the BBBY turnaround debate? I don’t think it’s going to happen. New management could turn things around, and in the event that they do, Bed Bath & Beyond stock could be due for a huge rally towards $40 over the next several years. But, the chances of that happening are very slim. It’s far more likely that, regardless of the management team, the retailer continues to be challenged by adverse secular trends, and that the numbers remain weaker for longer. In that scenario, BBBY stock could be due for a pullback toward levels below $15.
All in all, BBBY stock doesn’t look great here. There’s a slim chance the stock is on the cusp of a breakout to $40. But, it’s far more likely the stock will retreat to below $15.
How a Turnaround Could Happen
There’s a slim chance that Bed Bath & Beyond does get its act together, ends the current slide, and turns into a steady retail operation with healthy growth prospects.
How does that happen? The company shutters under-performing stores, and reallocates all investment back into the remaining stores to dramatically improve the in-store customer experience and end what has been a multi-year decline in in-store sales. This process would include giving the remaining stores a physical makeover, cleaning up inventory, implementing technology, improving floor displays, and adding in-store personnel.
At the same time, the company needs to continue to build out its digital business, and start to integrate its offline operations with its online operations by more robustly developing things like buy-online, pick-up-in-store. They also need to cut out lower margin items, sacrifice those sales, and pivot customers towards higher margin categories, while reducing reliance on a coupon-focused sales strategy.
If the company does all this (and that’s a lot), there is a possibility for revenue growth to come back into the picture, and for gross margins to head higher alongside opex leverage. If so, Bed Bath & Beyond could be looking at $12 billion-plus in sales by 2025, on roughly 5% operating margins. That combination could easily produce $4 earnings per share of BBBY stock.
Based on a historically average 10-times forward multiple, that implies a fiscal 2024 price target of $40. Discounted back by 10% per year, that equates to a fiscal 2019 price target for BBBY stock of nearly $25. Thus, in an “everything goes right” scenario, upside in Bed Bath & Beyond stock looks good from here.
Why It Likely Won’t Happen
Even if management does everything right (they close under-performing stores, improve the remaining store base, build out the omni-channel business, and reduce reliance on lower margin sales), there is still only a slim chance that all those moves produce a healthy return.
Why? The harsh reality here is that the consumer world has moved on from Bed Bath & Beyond and the company is so far behind its peers that even modest improvements will still leave them behind the curve. For example, let’s say Bed Bath & Beyond does go big into omni-channel commerce and builds a really strong buy-online, pick-up-in-store program. Walmart (NYSE:WMT) and Target (NYSE:TGT) already have that at scale, while Amazon (NASDAQ:AMZN) is working on drone delivery, and all three of those companies sell pretty much the same stuff as Bed Bath & Beyond at roughly the same prices, or lower.
So, as a consumer, even if Bed Bath & Beyond successfully built out its omni-channel business, I have no reason to all the sudden stop shopping at Walmart, Target, and Amazon, and go to Bed Bath & Beyond. The same is true for in-store improvements, an expanded digital business, so on and so forth.
Of course, the one thing Bed Bath & Beyond can do is lower prices, but that’ll hurt gross margins, and ultimately put them in a price war with Amazon, which is a battle they won’t likely win.
All in all, then, the outlook for a Bed Bath & Beyond turnaround here is bleak. Consumers have moved onto other stores, and there’s no compelling reason for them to come back. So long as this remains true, BBBY’s earnings will likely be stuck around $2 per share. Assuming that’s where earnings land by 2025, the same math above produces a 2019 price target for BBBY stock of under $13.
Bottom Line on BBBY Stock
Roughly speaking, I think there’s an 80% chance BBBY stock ends the year around $13, and a 20% chance the stock pops to $25. Those probabilities produce a weighted average price target of right around $15. With BBBY stock currently trading substantially above that level, the present risk/reward asymmetry on the stock is not great.
As of this writing, Luke Lango was long TGT and AMZN.