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A shopper walks by a wall display of kitchen implements at a Bed Bath & Beyond store in Richmond Hill, Ont. (Jim Ross/The Globe and Mail)
A shopper walks by a wall display of kitchen implements at a Bed Bath & Beyond store in Richmond Hill, Ont. (Jim Ross/The Globe and Mail)

Vox

Bed Bath & Beyond squeezed by pressures of Internet retailing Add to ...

Bed Bath & Beyond Inc., buoyed by its own reputation and boosted by a recovering U.S. housing market, rewarded shareholders in the first half of the year by climbing from below $60 (U.S.) to more than $75, an all-time high.

After that, however, the company cut guidance, erasing the gains. And a slow, steady climb back to the $70 mark was wiped out last week when the company’s earnings came in below Wall Street consensus. A temporary blip – and buying opportunity? Or signs of something worse?

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Here’s the bull case: Last week’s “miss” was a minor matter, as the company came in within its own forecast range for revenue and earnings per share but below analysts’ aggressive consensus. Same-store sales growth – sales at locations open at least one year – was a healthy 3.5 per cent, but again below Wall Street expectations.

The Union, N.J.-based company has a “best-in-class business model which has consistently produced industry-leading financial results,” says analyst Peter Benedict of Robert W. Baird & Co. “Superb execution has supported consistent top- and bottom-line outperformance during the recession and recovery.”

While Bed Bath & Beyond’s ability to grow store count is waning, it still has growth opportunities in Canada and with acquired chains like Oakland, Calif.-based Cost Plus World Market, which it bought this year.

A balance sheet with no debt and nearly a billion dollars of cash going into last quarter allows the company to engage in aggressive share repurchasing (a $2-billion program), boosting earnings per share.

And the recent pullback has pushed the trailing price-earnings ratio to about 14, and the forward P/E to about 12.5, per Standard & Poor’s Capital IQ. Outside the depths of the financial crisis, that’s about the cheapest the stock has been in its 20-year history as a public company.

Mr. Benedict has a price target of $70 – set before the recent decline – and a rating of “neutral,” however. His concern is that costs are accelerating as the company tries to deal with increasing Internet-based competition. At the same time, sales growth is moderating. That adds up to pressure on margins.

Indeed, the second quarter gross margin fell 1.27 percentage points compared to 2011 second-quarter levels. It was the third consecutive quarter of gross-margin declines, noted analyst Michael Lasser of UBS Securities LLC.

Mr. Lasser, who has a “neutral” rating and $71 price target, thinks much of the decline was due to the core business, not the inclusion of Cost Plus World Market’s lower margins in the results. The company itself cited more couponing – higher redemptions and a rise in the average amount – and a sales mix shift to lower margin products.

(Analysts also believe a significant reason for the company’s sales-growth deceleration, remarkably, owes to moderating growth in its sales of Keurig coffee machines and the associated K-Cups – another reason why Keurig parent Green Mountain Coffee Roasters Inc. has had issues with its share price.)

Mr. Lasser calls Bed Bath & Beyond’s gross margin erosion “problematic,” noting “there have been very few instances when a hardline retailer was experiencing substantial gross margin erosion and its shares were rewarded. Even if the pressure is largely temporary, the notion that it is more expensive to drive sales probably won’t sit well with the market.”

But is it temporary? Daniel Hofkin of William Blair & Co. LLC, who has an “outperform” rating on the shares thanks to the company’s return on capital figures (typically more than 20 per cent, after tax) and growth opportunities, says his firm’s research has suggested that merchandise at Bed Bath & Beyond is roughly 15 per cent to 20 per cent more expensive than comparable items on Amazon.com.

This, he says, makes it even more important for Bed Bath & Beyond to spend more to strengthen its e-commerce presence, as it plans to do this year.

Or it offers more concerns that this drop in the shares may not be the last. Bed Bath & Beyond’s ticker symbol is “BBBY” – coincidentally, one letter removed from the “BBY” of Best Buy. Now that’s a company that can tell you a thing or two about declining margins, softening sales and the competitive pressures of Amazon and Internet retailing.

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