Is Bed Bath & Beyond Finally Primed for Your Portfolio?

Source: Thinkstock

Source: Thinkstock

Bed Bath & Beyond (NASDAQ:BBBY) was punished after earnings with stock losses of 8 percent following its first-quarter report to touch 52-week lows. However, when compared to peers like Home Depot (NYSE:HD) or J.C. Penney (NYSE:JCP), is this reaction fair, and does its near 5 percent stock gains on the week of Independence Day suggest that investors see significant value in the company?

Not exactly apples to apples

Bed Bath & Beyond sells a mixture of goods and products that are unlike any other home furnishing retailer. For one, it sells many of the same home improvement products like kitchen fixtures and curtains as Home Depot or J.C. Penney, but lacks a large building materials segment like the former or a diversified clothing business like the latter.

Nonetheless, Bed Bath & Beyond, J.C. Penney, and Home Depot may not be apples to apples comparisons, but these three companies do have core similarities in home improvement as industry leaders.

What were the numbers?

With that said, Bed Bath & Beyond shares have fallen 30 percent in 2014 as pricing and increased competitive pressure from brick-and-mortar and e-commerce retailers have weighed on its store traffic, growth, and margins. In its first-quarter report, this was further put on display; the company grew revenue just 1.9 percent behind comparable-store sales growth of only 0.4 percent year-over-year.

Its gross margin declined 70 basis points to 38.8 percent, and its earnings-per-share midpoint guidance of $1.12 fell far below expectations for $1.20. However, management did reiterate mid-single digit EPS growth for the full year, implying the back half of the year will be strong following a poor start to 2014.

It could be worse

Here’s the bottom line: with nearly $11.6 billion in annual revenue and an operating margin of 14 percent, Bed Bath & Beyond may be nearing its fundamental peak. The days of significant growth that exceeds gross domestic product, or GDP, may be behind the company, and it could very well grow in connection to the overall economy rather than exceeding it.

However, this isn’t necessarily a bad thing. In fact, it could be a lot worse: J.C. Penney’s comparable-store sales have declined 25.2 percent and 7.4 percent in the last two years, respectively. Not to mention J.C. Penney’s gross margin has declined from 36 percent in 2011 to less than 30 percent in full-year 2013. Hence, Bed Bath & Beyond looks pretty solid compared to J.C. Penney and its operating margin of negative 9.5 percent.

Worth far more

Furthermore, sales growth that tracks GDP growth is  not horrible. Analysts expect the company to grow revenue by 3.8 percent in each of the next two years. By comparison, Home Depot should grow revenue 4.7 percent and 4.5 percent in 2014 and 2015, respectively. This growth is created due to the fact that home improvement as an industry remains a bright spot in retail.

Yet, assuming these growth levels are met, investors should identify the rather large disconnect in each company’s valuation. Bed Bath & Beyond trades at just 11.2 times forward earnings, while Home Depot trades at 16 times next year’s earnings. In other words, for a whole percent of additional growth, Home Depot is being given a forward earnings multiple that is nearly 50 percent greater than Bed Bath & Beyond’s.

Albeit, Bed Bath & Beyond is either very cheap or Home Depot is significantly overvalued. At 20.5 times current earnings, Home Depot is a bit pricey, but since it has outgrown GDP, investors have been willing to pay the premium. Therefore, Bed Bath & Beyond may not be worth the same multiple on earnings, but common sense suggests that it’s worth far more than its current valuation.

Final Thoughts

Bed Bath & Beyond was a high-flying stock in the five years prior to 2014, as its double-digit growth was celebrated on Wall Street. However, stocks tend to trade too high during long-term rallies and fall too low when growth slows, which is the point we currently have in Bed Bath & Beyond. As a result, Bed Bath & Beyond may trade lower in the next couple of months; it may trade flat for six months. But long-term fundamentals usually reflect in the valuation of a company. In this particular case, Wall Street just needs to temper its expectations, which thereby should drive a cheap Bed Bath & Beyond stock significantly higher.

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