Bed, Bath, & Beyond: Management Needs to Break Its Piggy Bank

Currently trading at 17x EPS, shares of home furnishing giant Bed Bath and Beyond Inc. (NASDAQ:BBBY) looks incredibly cheap. It's either that or we should be scolded for our irrational exuberance.

Bed Bath & Beyond operates 760 Bed Bath & Beyond stores throughout most of the United States. The company also owns Christmas Tree Shops, a 31-store giftware and household items retailer, and Harmon Stores, a 38-store health- and beauty care retailer. The stores' floor-to-ceiling shelves stock better-quality bed linens, kitchen items, and home furnishings. BBBY, which employs 33,000 people, depends heavily on word-of-mouth for advertising to penetrate new customer segments and expand its top line. And with the acquisitions of Harmon Stores (2002) and Christmas Tree Shops (2003) under its wing, BBBY has had no qualms going outside the company to fuel that growth. Internal promotions and every-day low pricing have also contributed to BBBY's success. Sales have grown at a 19% clip over the last 5 years and free cash flow currently accounts for 8% of revenues.

While BBBY's P/E puts it at a premium to its 2Y EPS growth rate of 3.4%, the stock is trading @ over 15x cash flow, a sign that investors are assigning large value to BBBY's non cash assets. There is much to cheer about, we think, given BBBY's ROIC (Return On Invested Capital, or simply NOPAT/invested capital) over the last year was more than 23%. In addition, BBBY's EBITDA margins of 15.1% (120 bps higher than its comp group) are outstanding and should strike a chord with value investors who might also appreciate BBBY's conservative capital structure.

It is BBBY's capital structure, in fact, that most interests us. Currently, BBBY has amassed a cash horde of $817M and is debt free. Some its peers like JC Penny (NYSE:JCP: STRONG BUY), for example, are far more leveraged. This is a significant point of differentiation as it makes the possibility of an LBO event for BBBY all the more plausible. Additionally, the fact that founders Warren Eisenberg and Leonard Feinstein have slowly reduced their holdings to 2% of the company makes a potential deal easier to consummate.

Deal or no deal, BBBY is a in a great position to crack its piggy bank open and return this cash to shareholders either through more share repurchases or a meaningful acquisition, the latter which we think may be a good idea given that BBBY may be entering the maturity phase of its life cycle and thus needs to augment or redefine its value proposition. Besides, if Frank the Tank has time to stop in BBBY, it may be worth your time...

Frank: I told my wife I wouldn't drink tonight. Besides, I got a big day tomorrow. You guys have a great time.
College Student: A big day? Doing what?
Frank: Well, um, actually a pretty nice little Saturday, we're going to go to Home Depot. Yeah, buy some wallpaper, maybe get some flooring, stuff like that. Maybe Bed, Bath, & Beyond, I don't know, I don't know if we'll have enough time.

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