Late in 2016 and after Bed Bath & Beyond (BBBY) reported their Q3 2016 results I authored a detailed analysis of the company’s results and state of business operations. In the article titled Bed Bath & Beyond Gross Margin Contraction Seems Never Ending I discussed the continued issues plaguing Bed Bath & Beyond’s metric performance. And it is with respect to my previous analysis that this article will serve to recap Bed Bath & Beyond’s Q4 2016 results, the retailer’s 2017 guidance and analyze the quarter that was. But before doing so let’s take a look at what the company reported in the Q3 2016 period to serve as a guide into the recently reported Q4 2016 period.

The Company reported FQ3 EPS of $0.85 that missed by $0.13 a share and revenue of $2.96B (+0.1% Y/Y) that missed by $50 million. In reporting sales, the company boasted greater than 20% digital sales growth while total same-store-sales fell 1.4% versus the same period a year ago. Quite a dismal performance for the retailer yet again! Moreover, if it weren’t for the recent acquisitions and new store openings, total net sales would have been negative for Bed Bath & Beyond in the quarter reported.

The Q3 2016 report was not the only reporting period for which Bed Bath & Beyond had missed estimates. The company has been missing analysts’ estimates for the better part of the last 6 quarters. As such, the share price has been cut in half since 2015. The most consistent and relevant problem surrounding Bed Bath & Beyond’s business has been the continued gross margin contraction. Bed Bath & Beyond is experiencing all-time low gross margin performance, seemingly contracting for every quarter and on a YOY basis for several years now. It’s one of the reasons I had disposed of my investment in the retailer in 2015 and at the high share price of $76 through UBS, which handles Bed Bath & Beyond restricted stock grant ownership. 

My concerns over the retailers' gross margin performance surfaced in 2014 and continued through 2016. As early as June 2014, I pre-warned investors about my gross margin considerations in the article titled Bed Bath & Beyond's Gross Profit Looks Worrisome. In 2015 and as I saw gross margin performance further deteriorating, I sold my stake in the company and further detailed the issues in an article titled Bed Bath & Beyond's Gross Profit Margins Come Home To Roost. One of the tables I offered to investors back then was a review of the company’s previous yearly gross margin performance as depicted below:

Based on what Bed Bath & Beyond has reported even since 2015 and as recently as yesterday, the retailer is currently expressing a 38% profit margin, nearly 170 basis points lower than 2013. One of the most alarming facts about the table depicted is that Bed Bath & Beyond is expressing lesser gross margin performance than during the Financial Crisis and subsequent recession. Projecting “beyond” that, one has to factor in what the business would express should another recession take place in North America. And thusly, that brings us to the company’s most recently reported results and guidance for FY17. 

On April 5, 2017 and after the closing bell, Bed Bath & Beyond beat analysts estimates on the bottom line by reporting net earnings per diluted share of $1.84 against estimates of $1.77 a share. While the bottom-line beat was unexpected by some, net sales were in-line with analysts’ estimates at a reported $3.5 billion in sales. This was an increase of approximately 3.4% compared to the prior year period. Comparable sales increased approximately 0.4%. The vast majority of the comp sale increase was due to comparable sales from customer-facing digital channels growing in excess of 20% while sales from stores declined in a low single-digit percentage range. Unlike previous quarters, management did not give the exact level of the comp store sales decline. Moreover, it is important to understand as it pertains to sales that the vast majority of the sales increase came from the inclusion of recent acquisitions such as Pmall and One Kings Lane as well as new store openings. This was outlined by management on the conference call as follows:

This increase is primarily due to a 3% increase in non-comp sales including PMall, One Kings Lane and new stores and a 0.4% increase in comp sales.

In other words, if one were to strip out new stores and acquisition of sales, the company would have only grown sales during the Q4 2016 period by .4 percent. Of course, 100% of the company’s stated sales growth also came at the cost of gross profit margins and resulted in overall YOY earnings per share decline. Remember, the company reported net earnings of $1.84 in Q4 2016, but reported net earnings of $1.91 in Q4 2015. So the earnings reported for the most recent quarter basically beat analysts lowered expectations, but still fell YOY. 

Looking at the full year that was 2016 for Bed Bath & Beyond, the company reported net earnings per diluted share of $4.58 compared with $5.10 per diluted share in 2015. It was quite the dismal year for the retailer in 2016 based on EPS performance. Net sales were approximately $12.2 billion, an increase of approximately 0.9 percent. Comparable sales decreased approximately 0.6%, and comparable sales from customer-facing digital channels grew in excess of 20% while sales from stores declined in a low single-digit percentage range. In truth, the sales growth was very meager and obviously came at a great cost not just to the company, but to shareholders. 

In speaking of the company’s gross margin performance for Q4 2016, the trend did not break. Bed Bath & Beyond reported another gross margin contraction on a YOY basis. Gross margin was approximately 38% as compared to approximately 38.6% in the prior year period. The variables surrounding the continued gross margin contraction remain the same as they were in previous quarters and years.

• Increase in net direct to customer shipping expense as a result of more promotional shipping offer activity including a change in the Bed Bath & Beyond free shipping thresholds from $49 last year to $29 this year.
• Free shipping for the first few days of the quarter, which included Cyber Monday.
• Increase in coupon expense resulting from increases in redemptions and the average coupon amount.

Furthermore, with regards to gross margin expectations, Bed Bath & Beyond is anticipating a continuation of gross margin contraction for 2017. So let’s take a further look at what the company expects in the way of its metric performance for 2017, shall we?

Taking into account the 53rd week in fiscal 2017, Bed Bath & Beyond is modeling a low to mid-single-digit percentage increase in consolidated net sales for the full year. Most of the sales growth will likely continue to come from new store openings and customer-facing digital channels. The comp sales range is from relatively flat to slightly positive and includes continued strong growth in customer-facing digital channels. The gross margin deleveraging is expected to come from net direct to customer shipping expense and coupon expense as it has been for several years now. Naturally, with continued gross profit margin contraction and minimal net sales growth, Bed Bath & Beyond is modeling a decline in net earnings per diluted share in the percentage range of low-single digits to 10 percent for fiscal 2017.

The outlook for the company remains very questionable based on the profit outlook and earnings per share forecast offered by the company, even as they have initiated and implemented several new programs. But I want to step back for a moment and ask investors to review what the company did regarding capital expenditures (CAPEX) during the Q4 2016 period. In reading the company’s conference call transcript for the most recently reported quarter, it is understood that the company deferred some of its planned CAPEX for the period.

Capital expenditures for the year were approximately $374 million, with some of the anticipated spend for 2016 moving into 2017. CapEx for the year included the following; enhancements to our digital capabilities; ongoing investments in our data warehouse and data analytics; expenditures for the continued development and deployment of new systems and equipment in our stores, including the implementation of our new POS system into some of our stores; investments in new systems and support to accelerate the expansion of our online assortment; the replatforming of One Kings Lane's systems and integration of its support services; spending related to the opening of our new distribution facility in Lewisville, Texas; the expansion of our customer contact center in Layton and enhancements to its systems; and investments in new stores, including the opening of BEYOND at Liberty View in Brooklyn, store relocations and store refurbishments. 

Whenever a company does something like this, deferring all-important CAPEX, it tends to mask profitability further. More importantly, such actions around CAPEX tend to negatively show up in subsequent quarters. Bed Bath & Beyond has actually been doing this now for a couple of years, moving about $50mm in CAPEX planned for the year out to the next year and in consecutive years. This is always a red flag for me despite what some may believe to be prudent planning. I would offer the stock price and metric performance align with the skeptical sentiment I’ve offered. But with all that being said, the retailer has modeled CAPEX to be relatively flat in 2017.

With the company’s recent acquisitions of Pmall and One Kings Lane, this activity continued in March of 2017 with the acquisition of Decorist. Additionally, Bed Bath & Beyond also acquired certain assets from Chef Central in February for roughly $1mm. Obviously, a million dollar acquisition here and there isn’t going to right all that plagues a multi-billion dollar business. While these activities have previously given a slight bump to the top-line, they have absolutely no impact on the bottom line based on size and scale of the acquired business.

Moreover, the only activity that has actually proven to stem the plummeting of the earnings per share performance is the company’s standing share repurchase program. Share repurchases under the current $2.5 billion share repurchase program were approximately $171 million in the fourth quarter, representing about 4.1 million shares. This authorization had a remaining balance of approximately $1.7 billion at the end of fiscal 2016. Bed Bath & Beyond has significantly reduced the float over the last several years to the point where it is forced to exhibit a positive sentiment in its company’s future. After all, what choice does the company have seeing as during this period, the stock price has fallen dramatically and as they’ve expensed this buyback program?

Final Thought

Despite the bump in the share price on April 6, 2017 and after the company issued FY16 results and FY17 guidance, the retailer has its work cut out for it. What has been and remains very clear is the trend regarding EPS and gross profit margins remains intact and quite negative overall. I’ve never witnessed organic PE expansion for a company that has offered negative EPS guidance, and as such, investors might use the current bump in share price to trim capital allocated to BBBY shares. But that remains to be seen. As for the Golden Capital Portfolio, I will be monitoring the company and stock near-term. Should the share price achieve $42-$43, I will be initiating a small short position in the name as the company’s issued guidance suggests a lower share price over the mid-term. Bed Bath & Beyond is a strong retailer and has a healthy balance sheet, relatively speaking. Having said that, the headwinds the company is facing have proven to be insurmountable given the rapidly evolving retail environment. The CEO has gone so far as to admit to this sentiment in terms of deteriorating earnings per share and gross profit margins. In short, no pun intended, Bed Bath & Beyond did not report a single improvement in metric performance for Q4 2016 or FY16. Essentially the latest report simply wasn't as bad as some may have anticipated; that's not an ideal investment thesis or a thesis that tends to exude a bullish sentiment long-term.