Bed Bath & Beyond: Morgan Stanley Cuts Targets, Stays Underweight

• Bed Bath & Beyond Inc. BBBY shares are down 22 percent year-to-date, reaming below the $70 mark since end-June.
• Morgan Stanley’s Simeon Gutman maintained an Underweight rating on the company, while reducing the price target from $71 to $61.
• The impact of share repurchases on Bed Bath & Beyond’s profits has been offset by EBIT declines, and profitability continues to be under pressure, given the company’s omni-channel transformation.

Bed Bath & Beyond is in the midst of an omni-channel transformation, which exerts pressure on its margins. This transformation seems to be “lasting longer and more costly than expected” for most retailers, analyst Simeon Gutman said.

There is “an ongoing negative margin transfer” from store sales to online sales, against the backdrop of increasing competition in home furnishings retail. Moreover, Bed Bath & Beyond’s gross profit pools seem to be under pressure due to “an ongoing product mix shift from soft goods to hard goods,” Gutman wrote.

These factors affected the company’s Q2 results. Although there was a marginal improvement in a couple of metrics, it was insufficient to be considered a true inflection. At 3.5 percent y/y, not only was EPS growth modest, but it was driven mostly by share buybacks. Moreover, EBIT dollars declined 5 percent y/y.

Gutman added, “Q2 represents the 7th consecutive quarter in which EPS growth outpaced EBIT dollar growth by more than 6% (average differential of ~9%).”

In the report Morgan Stanley noted other key investment issues visible in the company’s Q2 results:

1. Top-line comps stood at 1.1 percent, versus 3.4 percent in the prior year.
2. Gross margin contracted ~40 bps, representing the 15th consecutive quarter of erosion.
3. The company remains in investment mode, with SG&A dollars rising 3.3 percent, versus 1.7 percent sales growth.
4. 1H EBIT dollars were down 7 percent, while free cash flow plunged 37 percent.

The price target reduction reflects lower multiples, which is “consistent with the current multiple and reflects a lack of stabilizing profitability,” Gutman explained.