A Financial Analysis and Valuation of Bed Bath & Beyond · BBBY has marginal negotiating power with its suppliers. Although BBBY has developed strong relationships with select suppliers,

A Financial Analysis and Valuation of Bed Bath & Beyond

1 Harvard College Analyst Report | Bed Bath & Beyond

EXECUTIVE SUMMARY

Historical Performance

Our analysis of Bed Bath & Beyond (“BBBY”) revealed strong profitability for the firm

and its investors as well as consistent growth over our time period of study spanning FY

2000-10. As a company focused on selling consumer durables, BBBY was inevitably

affected by the decline in consumer spending during the recession, but managed to

weather the difficult conditions affecting the overall macroeconomic environment

relatively well compared to other retailers. Overall, BBBY’s stable cash flows, lack of

debt and other strong technical fundamentals made BBBY a very attractive company over

the past decade, as validated by the rapid growth in its stock price during this time.

Key Observations

The recession was the primary reason why BBBY’s profitability ratios such as ROA and

ROE decreased by 6% and 10%, respectively, in 2007 and 2008. Further decomposition

of these two ratios, however, provided insight that these decreases were not a result of

volatile changes in cost structure or turnover, but rather strategic manipulation by

management to lower profit margins and increase coupon redemption to boost sales.

Since 2008, the company’s profitability ratios have returned to pre-recession levels, and

we expect the company to post steady positive gains in the coming years.

BBBY’s capital structure is unusual in the sense that the company holds relatively little

debt, reflecting a business model that is financed nearly entirely by equity. Since 2008,

the company’s current ratio has steadily increased as a result of increases in cash, and

though nearly half of its current assets lie in inventory, BBBY’s deepened cash reserves

mitigate any possibility of short-term liquidity issues.

Our financial statement and valuation analysis also led us to look at BBBY’s cash

management. Using the residual income valuation method, we observed that without any

current changes to how management uses the company’s cash, BBBY’s cash reserves

would exceed $8bn by 2020, representing 68% of total assets. Therefore, BBBY can

either use cash to take on cheap debt (especially in the short term) or return cash to

investors in the form of a dividend or stock repurchase.

Findings and Conclusions

Our discounted cash flow model and relative valuation analysis value BBBY at $69.92

with benchmarks in-line with peer group industry averages. Our residual income

valuation model values the company at $55.88, suggesting that BBBY is overvalued

today at a share price of $69.41. Hence, we are likely to put a “Sell” rating on the stock,

though a “Hold” rating is also a viable option for the risk-averse investor.



COMPETITIVE AND ECONOMIC ENVIRONMENT

Description

Bed Bath & Beyond (BBBY) is a chain of retail stores located primarily in the United

States and Canada. The chain’s brands include Bed Bath & Beyond, Christmas Tree

Shops, Harmon and Harmon Face Values, and buybuy BABY. BBBY primarily sells

mid-ranged domestic merchandise and home furnishings. The Company currently has

1,139 stores in the United States, Puerto Rico, and Canada and has a current market

capitalization of $16.4bn.

Market Fundamentals

Source: U.S. Bureau of Economic Analysis

Source: The Federal Reserve Economic Database

The US furnishing and household

equipment market is very fragmented and

competitive. Indeed, there are many

different types of household goods that

can fall into this category, and many

retail stores address the various sub-

categories of this market. BBBY

competes with local, regional, and

national retailers that include specialty

retailers, department stores, discounters,

and online retailers. From Figure 1, the

market peaked at $271bn in 2007 but has

since contracted to $235bn in 2009. In

2010, consumer spending went up to

$244bn.

Despite this muted increase, consumer

sentiment remains relatively depressed,

as seen in Figure 2. With consumer

confidence remaining low in the wake of

the recent recession, it is difficult to

imagine a large upswing in consumer

spending occurring in the near future.

Since BBBY specializes in selling home

furnishings and domestic merchandise

it’s financial success is very closely

related to the housing market. The Wells

Fargo National House Market Index is a

measure of the number of sales sold each

month (seasonally adjusted).

0

50

100

150

200

250

300

Do

llars

Sp

en

t (i

n b

illio

ns)

Fiscal Year

Figure 1: Home Furnishings Consumer Spending

0

20

40

60

80

100

120

Figure 2: Consumer Sentiment



Figure 2 – Standard and Poor’s.

The Case-Shiller Home Price Index is a measure of the price of homes sold each month

(also seasonally adjusted). From Figure 3, the prices for homes appear to have retraced

greatly over the past five years, dropping more than 25% as measured by the Case-Shiller

index. Similarly, Figure 4 shows that home sales remain well below pre-recession values.

Yet, despite the depressed state of the U.S. housing market, BBBY has seen a continual

and strong increase in net sales. BBBY appears to remain on an upward trend even in the

wake of the recent recession. Despite this continued increase in net sales, however, the

potential for further decline or continued stagnation in the housing market remains a

nontrivial concern for BBBY.

Source: Wells Fargo

0

50

100

150

200

250

Ind

ex

Figure 4: Case-Shiller Home Price Index

0

10

20

30

40

50

60

70

80

Ind

ex

Figure 3: Wells Fargo National HMI



Short-term Challenges

The past few years have clearly presented an unfavorable economic climate for the home

furnishing retail industry. The collapse of the housing market and subsequent recession

has precipitated a decline in consumer spending, especially discretionary spending.

Nevertheless, BBBY has averaged a 5% increase in same store sales and increased its

number of stores fivefold over the past ten years. Moreover, in 2008, BBBY’s main

competitor, Linens ‘n Things, went bankrupt and was liquidated. This collapse of its

closest competitor has buoyed BBBY’s sales and performance at a time when the home

furnishing market has shrunken markedly. We are therefore unable to disentangle

BBBY’s strong performance during the recession from the concurrent collapse of its

nearest competitor, naturally begging the question of whether BBBY will be able to

maintain its recent growth.

Bed Bath & Beyond must

focus on increasing same store

sales. Much of the percent

increase in store sales has

come from the first few years

of a store’s opening while

older stores have reached a

plateau in sales. BBBY must

therefore reassess and retool its

growth strategy as market

penetration increases and new

store openings become less

likely. The focus should

instead be on improving same

store sales.

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Figure 5: End of Year Store Count

-4

-2

0

2

4

6

8

10

Pe

rce

nta

ge C

han

ge

Figure 6: Percent Change in Same Store Sales



Long-term Challenges

In the long-term, BBBY must focus on its market share and actively work to maintain its

positioning in the face of increasing Internet sales. In fact, for the past five years, there

has been double-digit growth in online retain sales, a trend which eMarketer expects to

continue in the near term. For instance, in the home furnishing online market, eMarketer

expects sales to have double-digit growth through 2016; in 2010, home furnishing online

sales were at $11.9bn and is expected to grow to $18.8bn by 2013 and $26.6bn by 2016.

To combat this new competition, BBBY will have to either bolster its online presence or

break into the international market. BBBY currently does not have the infrastructure to

handle a large increase in online sales.

Figure: 7: U.S. Online Retail Sales

Source: eMarketer

BBBY will have to reconsider its current operating model as its stores mature in their

local markets. As of FY2011, BBBY only operated three central distribution centers.

Most of its merchandise is on display at the sales floor at all times; the remaining stock is

stored in the back of the stores. Third-party vendors ship the vast majority of supplies to

the local stores because BBBY does not have the capacity to service itself. As an

expanding company, this strategy has allowed BBBY to strategically place stores in areas

without warehouses relatively quickly and to remain lean and flexible. However, as

BBBY grows larger, it must consider revamping this system in order to gain greater

bargaining power with its suppliers, provide consistent brands across stores, and maintain

more control over its distribution chain. Bed Bath & Beyond currently fails to take

advantage of the economies of scale that can come with the operations of a large retailer.

Furthermore, this current decentralized model prevents BBBY from being an effective

player in the online retail market.



COMPETITIVE FACTORS

Buyer Power

In today’s market, retail stores have increasingly less power relative to the consumer.

Consumers have local mom-and-pop shops, regional shops, and national shops from

which to purchase their furnishings. Even within the national shops, there are many

retailers who specialize in other wares, but inevitably sell similar goods. Finally,

consumers have with increasing frequency gone to the Internet to purchase their goods.

Many of today’s consumers do not care about the brand of the stores, but rather the

brands of the goods. Furthermore, eMarketer claims that 45.9% of shoppers have

researched a product in a store before purchasing it online. Thus, the buyer has gained a

significant advantage over the brick-and-mortar retailers.

Supplier Power

BBBY has marginal negotiating power with its suppliers. Although BBBY has developed

strong relationships with select suppliers, some of its suppliers are only regional. In

FY2010, BBBY had roughly 5500 suppliers, with the largest supplier accounting for less

than 5% of merchandise purchases. Each BBBY store (or group of BBBY stores)

purchases its own supplies and warehouses them individually. Despite its size, BBBY is

not one of the largest customers for many of its suppliers. It instead believes that this

method allows it to quickly switch from one supplier to another, as it does not highly

value brand. If BBBY becomes more centralized, it will have more bargaining power

with its suppliers becoming a more significant customer to many of its suppliers.

Threat of New Entrants

Retail shops are relatively easy to open; new entrants do not need much capital or

expertise. However, many local mom-and-pop shops do not survive in this saturated

environment because consumers prefer shopping at chain stores, where the quality of

service, expertise, and supply of goods is known. Because BBBY often deals with

suppliers on a regional basis, BBBY does not have a highly sophisticated and established

distribution chain that would give it a significant advantage over new entrants. Therefore,

BBBY only has its brand as a barrier to entry for new competitors. In the domestic

merchandise market, many national and regional retailers, who specialize in other

domestic goods, are encroaching on the BBBY’s established market. For big players with

established supply chains and the shelf space, selling home furnishings or domestic

merchandise is the next logical and easy step.

Threat of Substitutes

There is very little threat of substitute for the goods that BBBY sells; people will always

need their domestic merchandise. However, as mentioned in the “Buyer Power” section,

customers have many options for where they can shop. As a whole, brick-and-mortar

retailers are negatively impacted by the rise of the Internet and thus retailers will become

increasingly threatened, as online purchases become viable substitutes for actual store

visits.



Rivalry Among Existing Firms

Since the bankruptcy of Linens ‘n Things, Bed Bath & Beyond has had one big rival:

Williams-Sonoma. However, Kohl’s and Pier 1 Imports also compete in the same market.

Many of these companies are chasing stagnant or falling consumer dollars. In addition to

these close rivals, BBBY does face competition from retailers in adjacent markets such as

IKEA or Wal-Mart. Even though the retail market is highly competitive, BBBY has an

established brand that is well known for high quality customer service. As a national

brand, BBBY performs strongly in its saturated market. BBBY has gained market share

in the most recent years because of its customer service and diverse product offerings.

Strategy

BBBY has always had great customer service and therefore often outperforms other

brick-and-mortar retailers. The high quality of service allows it to differentiate itself from

its closest competitors. It advertises itself as a one-stop shop for all possible home needs.

A core strategy for the firm has been to offer more low margin items to increase customer

choice and sale value. In fact, BBBY reported lower gross margins but higher gross profit

growth these past few quarters because BBBY has recently begun pushing the

introduction of more coupons in order to attract customers. The increased merchandise

offering has driven sales productivity. 80-90% of BBBY’s inventory is out on the floor

for customers to view. The idea is that with “everyday low prices,” customers may find

goods that they “need” as they walk through the stores. In addition, BBBY wants to

present itself as a collection of specialty stores with related product lines grouped

together. This method allows a customer to focus his search for specific needs, yet

increases the chance that a customer finds related items to purchase.

In FY2010, BBBY opened many stores with its nimble distribution operations. The

depressed real estate prices allowed BBBY to open stores in previously expensive

locations. This strategy should continue through 2012. BBBY lists its expansion program

as one of its greatest successes; from FY1992 to FY2010, the company grew from 34 to

1139 stores. This expansion program includes a management structure that allows BBBY

to immediately place high quality managers in new locations. As the more obvious store

locations disappear, BBBY should begin to consider how to retool its strategy for future

growth in a method less dependent upon the opening of new stores to drive growth.

Return on Assets

We begin our analysis of Bed Bath and Beyond by assessing the profitability of the firm.

To do this, we consider the evaluation of several key ratios beginning with BBBY’s

Return on Assets (ROA) ratio. ROA measures the profitability of all capital invested in

the firm regardless of capital structure.



Source: Financial Reports

Figure 8 shows that BBBY’s ROA held relatively stable at the beginning of the decade

with an ROA of over 16%. Beginning in 2006, however, we notice a significant decline

in BBBY’s profitability. Because this is a company that specializes in affordable

domestic merchandise relative to higher-end competitors such as Crate and Barrel and

Williams Sonoma, we were not surprised that BBBY’s performance was greatly affected

by macroeconomic trends. Concurrent with the recent financial recession and collapse of

the housing market was a precipitous decline in BBBY’s ROA, dipping as low as ~11.0%

in 2008 before recovering after the recession to pre-FY 06 levels.

In the MD&A section of the company’s FY 2008 10-K, they note that: “The Company

believes factors such as the increase in the unemployment rate and issues specific to the

housing industry, including a decline in home values in conjunction with a downward

trend in home sales, have negatively impacted consumer confidence and the level of

discretionary spending by consumers, resulting in an adverse impact on the Company’s

net sales, net earnings and operating cash flows.” Though BBBY is a retail company that

relies on operating leases for its stores, operating leases accounted for just 7.8% of total

assets in FY 2010. For this reason, we have decided not to exclude operating leases in the

firm’s total asset calculation, as the effect of excluding operating leases would have had

little effect on BBBY’s profitability.

ROA Decomposition

We have broken down Return on Assets into two ratio components: Asset Turnover and

Profit Margin. Asset turnover measures the efficiency with which BBBY is using its

assets to generate sales, while the profit margin measures how much of every dollar in

sales BBBY actually keeps in earnings. As we have learned, the two ratios generally

move in opposite directions: companies with lower profit margins tend to have higher

0.0%

4.0%

8.0%

12.0%

16.0%

20.0% R

OA

Figure 8: BBBY's Return on Assets



asset turnover, while companies with higher profit margins tend to have lower asset

turnover.


Figure 9 shows some volatility in BBBY’s profit margins over the past ten years. Profit

margin trends follow ROA trends closely, suggesting that the decline in ROA during the

recession was due mainly to lowered profit margins rather than asset turnover. Even with

the volatility, BBBY’s profit margins hover around the high single-digits – a comfortable

position for a company with mid-price range market positioning in the industry. (For

comparison, higher-end competitors like Cost Plus and Pier 1 Imports post lower double-

digit profit margins.)

Profit Margin for ROA Analysis

From our decomposition, we observe that the profit margin rose steadily from 2000 to

2005, declined during the recession and then began rebounding in 2008. Figure 10,

however, shows us that the cost structure of the company in the last ten years has stayed

relatively constant despite changing business environments: COS, which includes Cost of

Goods Sold (COGS) and distribution costs, remained roughly constant as a percentage of

sales at 60%, whereas SG&A as a percentage of sales rested at approximately 30%.

Therefore, if COS and SG&A expenses are not accounting for the decrease in profit

margins from 2006 to 2008, we arrive at the conclusion that BBBY’s strategy was to

intentionally discount the price of its products – thereby lowering profit margins – to

keep sales afloat in the wake of tough macroeconomic conditions. This has been

accomplished through an increase in coupon redemptions and the shift in the mix of

merchandise sold to lower margin categories. As a result, though BBBY consistently

experienced double-digit growth in previous years, BBBY was able to capture year-over-

year sales growth of 6.5% and 2.2% in 2007 and 2008, respectively. We see then that our

0.00

0.50

1.00

1.50

2.00

2.50

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Ass

et

Turn

ove

r R

atio

Pro

fit

Mar

gin

s

Figure 9: BBBY's ROA Decomposition

Profit Margin Asset Turnover



fundamental ratio analysis validates the trends observed in the Competitive and

Economic Environment section of the report.


Asset Turnover Analysis

We observe from Figure 11 that inventory turnover stayed fairly constant from 2000 to

2010 but that PP&E turnover – also known as Fixed Asset turnover – decreased starting

from 2006 before returning to pre-recession levels after 2008. The fixed asset turnover

ratio measures a company’s ability to generate sales from PP&E investments. Thus, the

decline in PP&E turnover makes sense; as BBBY continued to make property and

equipment investments in 2006 and 2007 (25.8% and 20.7% growth, respectively), sales

slowed down considerably, thereby lowering asset turnover. However, PP&E consists of

just 20% of total assets, so the fluctuation in PP&E turnover did little to drastically affect

overall asset turnover.


0%

20%

40%

60%

80%

Pe

rce

nt

of

Sale

s

Figure 10: BBBY's Cost Structure Over Time

COGS/Sales SG&A/Sales

0.00

2.00

4.00

6.00

8.00

10.00

Figure 11: BBBY's Asset Turnover Analysis

Inventory Turnover PP&E Turnover

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

BBBY's ROE



Return on Equity Analysis

Return on Equity (ROE)

measures a company’s

profitability by showing how

much profit a company generates

for invested shareholders. In the

case of BBBY, the company has

no debt and offers no preferred

stock; its only offering is

common equity. Since equity

makes up a larger percentage of

the right side of the balance

sheet, it therefore comes as no

surprise then that BBBY’s ROE

follows a similar trend to ROA,

as seen in Figure 12.


When we decompose ROE, we notice that asset turnover and the leverage ratio (which

we define here as assets divided by equity) hold steady throughout our time period of

analysis. The decline in BBBY’s ROE from FY2006-08 is attributed to a decline in profit

margins for the same reasons stated in our ROA analysis.


EARNINGS QUALITY AND ACCOUNTING ISSUES

A close examination of Bed Bath & Beyond’s past 10K reports revealed few red flags

and accounting concerns. BBBY’s disclosures in its past financial reports were

transparent and relatively consistent year over year. In the sections below, we present our

financial evaluation of BBBY’s earnings quality through an analysis of accruals, one-

time charges and an examination of BBBY’s footnotes. The findings suggest that Bed

0%

5%

10%

15%

20%

25%

30%

Re

turn

on

Eq

uit

y

Figure 12: BBBY's ROE

0.00

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1.00

1.50

2.00

2.50

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Turn

ove

r/Le

vera

ge R

atio

s

Pro

fit

Mar

gin

s

Figure 13: BBBY's ROE Decomposition

Profit Margin Asset Turnover Leverage Ratio



Bath & Beyond’s financial statements accurately depict the current financial state of the

firm.

Accruals

Calculating Bed Bath & Beyond’s historical accruals from 2006-2010 yielded no

significant red flags. BBBY’s total accruals (Net Income-Cash Flow from Operations)

were negative throughout the 5-year interval, confirming that BBBY’s cash flow from

operations exceeded its net income. In FY2010, Bed Bath & Beyond had negative

current operating accruals. However, this can be attributable to having higher taxes

payable and a larger stockpile of inventory, which can be explained by the uncertain

consumer spending habits generated by the financial downturn.

Table 1: Accruals ($ millions)

2006 2007 2008 2009 2010

Total Accruals (NI-OCF) -88 -19 -52 -159 -305

Current Operating Accruals 88 129 107 88 -14

Non-current Operating Accruals -176 -149 -159 -247 -291

Net Accruals (NI-FCF) 547 629 552 -19 172



One Time Events/Changes Over the past few years, Bed Bath & Beyond has had relatively few one-time accounting

charges and/or changes to its accounting methods.

0

200

400

600

800

1000

Mill

ion

s o

f D

olla

rs

Figure 14: Net Income and Operating Cash Flow

Cash Flow from Operations Net Income



Asset Impairment BBBY notes that historically it has not impaired any of its long-lived or intangible assets.

The fair value of Bed Bath & Beyond’s intangible assets exceeds their book values.

However, within the footnotes, BBBY revealed that it may record asset impairments in

the future if the financial circumstances permit.

Reclassifications

Within BBBY’s 10K financial report, BBBY reported that in FY2006 it adopted a new

accounting strategy yielding a one-time $34.3 million net reduction in shareholder’s

equity. However, this change appears immaterial, since it did not drastically affect future

earnings.

Examination of Potential Red Flags

After a close examination of Bed Bath & Beyond’s financial data over the last 5 years,

there are no serious red flags that call into question the financial integrity of BBBY. The

few red flags that were identified can be explained by BBBY’s inability to unload a

larger amount of inventory than it was accustomed to. This led to an immaterial decrease

in net cash flow from operations from the previous year. It is important to note that these

increases in inventory can be explained by the onset of the financial crisis in 2007.

BBBY was able to respond to the worsened economic climate by limiting its inventory

purchases in 2008. Consequently, the Company did have negative free cash flow in

2007, which ordinarily would have drawn attention to the Company’s solvency.

However, BBBY is unlevered and has issued very little debt. The Company has utilized

its excess cash to repurchase stock, since it has utilized equity as a means of financing its

operations. Since BBBY has positive cash flow from operations and is not highly

levered, the large repurchases of stock are not worrisome.

Table 2: Examination of Potential Red Flags

2006 2007 2008 2009 2010

CFO < Net Income NO NO NO NO NO

CFO Decreased and Net Income Increased NO YES NO YES NO

Large Changes in Inventory, Receivables, or Payables NO YES NO NO NO

Large Adjustment Items NO NO NO NO NO

Negative Free Cash Flow NO YES NO NO NO

Dividends + Stock Repurchases > FCF YES NO YES NO NO

Large Non-Cash Acquisitions NO NO NO NO NO




Footnote Disclosures and Other Accounting Issues

Bed Bath & Beyond’s disclosures did not produce any material red flags. Detailed below

are some of BBBY’s most significant disclosures and their effects on BBBY’s financial

statements.

Cash and Cash Equivalents

BBBY classifies any liquid security with maturities less than three months as cash and

cash equivalents. Since BBBY identifies a small amount of assets as credit receivables

and has limited debt, BBBY’s liquidity is immaterially affected.

Inventories

Bed Bath & Beyond changed its method for calculating inventory costs for its subsidiary

buybuy BABY on March 2, 2008. Instead of applying the average inventory method,

BBBY calculated inventory costs using FIFO. Since buybuy BABY represents a

relatively small component of Bed Bath & Beyond’s overall business operations, this

change should be deemed as immaterial to BBBY’s financial statements. Of note, BBBY

estimates its shrinkage based on historical and current trends. Over the past decade, Bed

Bath & Beyond’s shrinkage has been relatively consistent.

Property and Equipment

BBBY records PP&E at cost according to GAAP standards. It records depreciation using

the straight-line method. BBBY charges maintenance and repairs to earnings. In 2007-

2009, the maintenance and repair costs were consistent and were $72.9 million, $81.1

million, and $86.2 million respectively.

Income Taxes In 2007, BBBY renewed its accounting guidance related to income taxes. Under this new

provision, the largest tax benefits included in BBBY’s financial statements are calculated

as the largest benefit that has been deemed as having greater than a 50% chance of being

realized upon clearance. Since BBBY is annually audited by a major accounting firm

that provides them with tax guidance, this change should not materially affect its

earnings.

Stock-Based Compensation

Bed Bath & Beyond records stock-based compensation awards using a fair value method

by recording compensation after it has been granted. BBBY includes stock options and

restricted stock awards when calculating stock-based compensation.

Summary of Analysis of Earnings Quality

Overall, Bed Bath & Beyond’s financial statements and financial disclosures found in the

footnotes contained within BBBY’s annual reports are extremely transparent and do not

raise significant red flags.



FORECASTING

The primary drivers of BBBY’s revenue are same store sales growth and the introduction

of new stores. BBBY has weathered the recession quite well, with same store sales

increasing by 4% in FY2009 and 8% in FY2010. To project forward same store sales, we

used the non-recessionary five-year average, as calculated by the past five years worth of

historical values, excluding the aberrantly low same-store sales decline witnessed in

FY2008. This produced a same store sales growth factor of 5.7%, which was then applied

to our projections. With respect to new stores, BBBY’s FY2010 10-K provided the

expectation of opening new stores in 2011 equal to roughly 4% of the current number of

stores. Given that 4% is already well below its five year average of nearly 7%, we viewed

this as a conservative and appropriate approximation, and thus new store openings were

projected forward as representing 4% of total stores. As indicated by our following pro-

forma financial statements, we expect BBBY’s store openings and same store sales

growth to continue to grow at the lower end of its pre-recessionary growth.

Revenues

BBBY has historically expanded its operations primarily via new store openings, in

contrast to acquisitions, a trend we expect to continue in the near to long term. Despite

the recent recession and the resultant widespread decline in discretionary spending,

BBBY has weathered the past few years quite well. The collapse of its largest competitor,

Linens ‘n Things, as well as its recent emphasis on providing low-cost items and budget

brands has allowed it to navigate this difficult economic environment with surprising

success. We expect these trends to continue and view our constant new store growth

projections likely even lie at the end of the potential spectrum insofar as they are based

off of the present expansion rate which is well below its pre-recessionary growth.

Moreover, if BBBY begins to capitalize on the economics of scale inherent in larger

operating models by establishing multiple larger distribution centers, it will greatly

reduce the per-store operating costs and thereby help to foster a much more rapid and

pronounced expansion in new store openings.


- 200 400 600 800

1,000 1,200 1,400 1,600 1,800

Figure 15: End of Year Store Count



As concerns existent stores, we expect sales growth to continue at a moderate rate of

5.7% per annum. Despite being below the 8% FY2010 growth, we view this rapid

increase in same store sales as being precipitated by exogenous shocks including the

financial distress of many of BBBY’s competitors, namely Linens ‘n Things. 5.7%

represents the non-recessionary average of BBBY’s same store sales growth and presents

a figure we consider to be very manageable. We further believe the present economic

climate to likely represent the nadir of consumer sentiment and that domestic home

furnishing spending will not retract further from its present level, but is instead more

likely to increase, thereby bolstering BBBY’s sales growth.

Table 3: Pro-Forma Store Count and Sales Growth ($ millions)

2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Store Count

1,139

1,185

1,232

1,281

1,332

1,386

1,441

1,499

1,559

1,621

1,686

Store Count Growth 3.5% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%

Same Store Sales

8,339

8,814

9,317

9,848

10,409

11,003

11,630

12,293

12,993

13,734

14,517

Same Store Sales Growth 7.8% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7%

New Stores

39

46

47

49

51

53

55

58

60

62

65

New Store Sales

419

436

454

472

491

510

531

552

574

597

621

Net Sales

8,759

9,251

9,770

10,320

10,900

11,513

12,160

12,845

13,567

14,331

15,138

Net Sales growth 11.9% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6%


Expenses

We projected forward BBBY’s cost of sales (COS) based on its historical COS/Sales

ratio of 58%. This ratio has been roughly constant over the past five years, and we do not

find anything inclining us to believe that BBBY will deviate from this trend. Similarly,

we project forward Selling, General & Administrative Expenses as 27% of net sales.

BBBY’s recent patterns have roughly mimicked this historical approximation, and we do

not expect any material changes to BBBY’s selling and distribution processes in the near

future. Interest Income has grown at approximately 3% over the past five years and we

projected forward interest income by forecasting future growth of 3%. Similarly,

BBBY’s historical combined income tax rate is 38.66%, and we projected future income

tax provisions by forecasting that BBBY will continue to face this combined income tax

rate. The marginal deviation of 2009 was attributable to a $3.2 million provision for the

recognition of certain discrete tax items as well as a partially offsetting adjustment in the

state tax rate on deferred income. We further assume no material changes in the corporate

tax levels and therefore forecast using the five-year historical average for the effective

corporate income tax rate.



Table 4: Pro-Forma Income Statement ($ millions)

2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Total Revenues

8,759

9,251

9,770

10,320

10,900

11,513

12,160

12,845

13,567

14,331

15,138

Costs of Sales

5,136

5,365

5,667

5,985

6,322

6,677

7,053

7,450

7,869

8,312

8,780

Gross Profit

3,623

3,885

4,104

4,334

4,578

4,835

5,107

5,395

5,698

6,019

6,358

SG&A

2,334

2,498

2,638

2,786

2,943

3,108

3,283

3,468

3,663

3,869

4,087

Operating Income

1,288

1,388

1,466

1,548

1,635

1,727

1,824

1,927

2,035

2,150

2,271

Interest Income

5

5

5

5

5

5

5

6

6

6

6

Pre-Tax Income

1,293

1,392

1,470

1,553

1,640

1,732

1,829

1,932

2,041

2,156

2,277

Income Tax Provision

502

538

568

600

634

670

707

747

789

833

880

Net Income

791

854

902

953

1,006

1,063

1,122

1,185

1,252

1,322

1,397


Balance Sheet Items

Projection of cash & cash equivalents was simply accomplished by adding the net change

in cash, as calculated in our pro-forma statement of cash flows, to the previous year’s

balance. The total change in cash for a given year is equal to the sum of net income plus

the net changes in operating, investing, and financing cash flows.

Our model assumes no growth in short-term investments beyond the present level. BBBY

holds such securities to accommodate excess free cash and its net amount of investment

securities has remained relatively constant historically. Inventory was projected to

remain constant as a percentage of sales at roughly 22.5%, which corresponds to its

historical average. We also projected other current assets to remain constant at its

FY2010 levels moving forward.

Long-term investments have remained fairly steady in recent years, and we forecast there

to be no growth above and beyond the FY2010 value moving forward. Similarly, other

long-term assets are projected to remain constant at its FY2010 levels moving forward.

Net PP&E is driven by our underlying assumptions in our pro-forma cash flow statement

concerning depreciation and expenditures. BBBY’s balance sheet as included in its

financial statements does not include a line item for accumulated depreciation. As a

result, we calculate Net PP&E as the previous year’s balance of PP&E plus capital

expenditures and minus depreciation expense. Capital expenditures have remained nearly

constant at 20% in the recent past, and we therefore use the three-year historical average

of 20.03% of net sales to forecast forward capital expenditures. Similarly, we forecasted

forward depreciation expense using the three-year historical average of 16.5%. From



these projections of depreciation expenses and capital expenditures we were able to

compute the Net PP&E observed in the balance sheet.

We projected accrued expenses, accounts payable, and merchandise credit based upon the

historical average percentage of total sales. We assumed no further growth in deferred

income tax over its FY2010 levels.

Table 5 : Pro-Forma Balance Sheet ($ millions)

2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Cash & Equivalents

1,184

1,230

1,287

1,348

1,414

1,486

1,566

1,653

1,750

1,858

1,977

Short Term Investments

606

606

606

606

606

606

606

606

606

606

606

Inventory

1,969

2,079

2,196

2,320

2,450

2,588

2,733

2,887

3,050

3,221

3,403

Other

316

316

316

316

316

316

316

316

316

316

316

Total Current Assets

4,074

4,230

4,404

4,589

4,785

4,996

5,221

5,462

5,722

6,001

6,301

Long Term Investments

121

121

121

121

121

121

121

121

121

121

121

Net PP&E

1,116

1,151

1,192

1,239

1,292

1,351

1,416

1,486

1,561

1,642

1,729

Other Assets

335

335

335

335

335

335

335

335

335

335

335

Long-Term Assets

1,572

1,607

1,648

1,695

1,748

1,807

1,872

1,942

2,017

2,098

2,185

Total Assets

5,646

5,837

6,052

6,284

6,534

6,803

7,092

7,404

7,739

8,099

8,486

Accounts Payable

710

736

777

821

867

916

967

1,022

1,079

1,140

1,204

Accrued Expenses

307

328

347

366

387

409

432

456

482

509

538

Merchandise Credit

193

204

216

228

240

254

268

283

299

316

334

Income Taxes

113

113

113

113

113

113

113

113

113

113

113

Total Current Liabilities

1,322

1,381

1,453

1,528

1,607

1,691

1,780

1,874

1,973

2,078

2,188

Deferred Rent and Other

292

292

292

292

292

292

292

292

292

292

292

Deferred Income Taxes

100

100

100

100

100

100

100

100

100

100

100

Total Long-Term Liabilities

392

392

392

392

392

392

392

392

392

392

392

Total Liabilities

1,715

1,773

1,845

1,920

2,000

2,084

2,172

2,266

2,365

2,470

2,581

Common Stock

3

3

3

3

3

3

3

3

3

3

3

Paid in Capital

1,191

1,191

1,191

1,191

1,191

1,191

1,191

1,191

1,191

1,191

1,191

Retained Earnings

5,546

6,400

7,302

8,255

9,261

10,323

11,445

12,631

13,883

15,205

16,601

Treasury Stock

(2,814)

(3,536)

(4,294)

(5,090)

(5,926)

(6,804)

(7,725)

(8,693)

(9,708)

(10,775)

(11,895

)

AOCI

5

5

5

5

5

5

5

5

5

5

5

Total Shareholder's Equity

3,932

4,064

4,208

4,364

4,534

4,719

4,920

5,138

5,374

5,629

5,906

Liabilities and Shareholder's

Equity

5,646

5,837

6,052

6,284

6,534

6,803

7,092

7,404

7,739

8,099

8,486




Forecasting Cash Flows

Given the scarcity of information pertaining to some of BBBY’s line items, we have only

provided line items for which there is a great deal of information and clarity and therefore

eliminated several historically volatile line items rather than attempting to forecast

forward their values without an adequate amount of information.

Operating cash flow is calculated as net income minus/plus any operating cash flows. As

is mentioned above, depreciation is forecasted forward as a percentage of total sales.

Similarly, cash flows from changes in inventory, accounts payable, accrued expenses and

merchandise credit are projected using their historical average percentage of net sales.

Investing cash flows are estimated using only capital expenditures, which we forecasted

forward, based on their historical percentage of net sales. We omitted several line items

pertaining to the purchase and sale of marketable securities insofar as based on the

limited information provided we do not have any reason to approximate such in-flows or

out-flows.

Cash flows from financing activities are equal to the repurchase of common stock,

including fees and issuance of dividends. We use this to control for the large cash

buildup in our valuations. Without putting its cash to use, Bed Bath & Beyond’s cash

reserves would exceed $8 billion by 2020. Bed Bath & Beyond, however, does not have

much use for this much cash, other than perhaps using it to make an acquisition.

Given its historical pattern of not engaging in acquisitions, it is far more likely that Bed

Bath & Beyond returns cash to investors through dividends or share repurchases.

Moreover, the company’s management announced in Q3 2011 that it would soon

commence a share buyback program. We projected forward future share repurchases by

applying a 5% per annum growth rate to the FY2010 value of share repurchases

inasmuch as this approximately represents the growth in net income. Doing so allows us

to more realistically model future growth in cash & cash equivalents.



Table 6: Pro-Forma Statement of Cash Flows ($ millions)

2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Net Income

854

902

953

1,006

1,063

1,122

1,185

1,252

1,322

1,397

Depreciation

153

157

162

168

175

182

191

200

210

220

Inventory

(111)

(117)

(123)

(130)

(138)

(146)

(154)

(162)

(172)

(181)

Accounts Payable

26

41

44

46

49

52

54

57

61

64

Accrued Expenses and Others

22

18

20

21

22

23

24

26

27

29

Merchandise Credit and Gift Cards

11

11

12

13

14

14

15

16

17

18

Cash Flows from Operations

956

1,014

1,066

1,123

1,183

1,248

1,316

1,388

1,465

1,546

Capital Expenditures

(188)

(198)

(209)

(221)

(234)

(247)

(261)

(275)

(291)

(307)

Cash Flows from Investing

(188)

(198)

(209)

(221)

(234)

(247)

(261)

(275)

(291)

(307)

Stock Repurchases and Dividends

(722)

(758)

(796)

(836)

(878)

(921)

(968)

(1,016)

(1,067)

(1,120)

Cash Flows from Financing

(722)

(758)

(796)

(836)

(878)

(921)

(968)

(1,016)

(1,067)

(1,120)

Net Change in Cash

46

57

61

66

72

79

88

97

107

119

Beginning Cash

1,184

1,230

1,287

1,348

1,414

1,486

1,566

1,653

1,750

1,858

Ending Cash

1,230

1,287

1,348

1,414

1,486

1,566

1,653

1,750

1,858

1,977


Earnings Per Share

Between FY2000 and FY2010, Bed Bath & Beyond’s earnings grew at a compound

annual growth rate (CAGR) of 16.2%, even after accounting for the recent recession.

This was driven by a 15.2% average annual increase in operating income and a 1.2%

annual decline in its diluted shares outstanding attributed to share buybacks.


$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

Figure 16: BBBY's Diluted EPS




Risk Profile With no long-term debt, the company’s exposure to financial market risk is relatively

low. It does not have regular interest payments it is expected to pay to debt-holders.

However, BBBY holds nearly 50% of its current assets in inventory. The high level of

inventory relative to cash and marketable securities accurately reflects Bed Bath &

Beyond’s business model but also contributes to some liquidity risk.

Current Asset and Liability Risk

BBBY’s current ratio stands at 3.1, has averaged roughly 2.5 over the last decade, and

bottomed out at 2.1 in 2007. The recent uptick in its current ratio reflects deepened cash

reserves, consistent with the overall theme of U.S. corporations’ behavior post-recession.

Given that management teams have incentives to maximize the current ratio, the

company’s maintenance of a current ratio around 2.5 is notable. Compared to the average

current ratio in the United States (near 1.0), Bed Bath & Beyond looks safe.

200000

220000

240000

260000

280000

300000

320000

Figure 17: BBBY's Diluted Shares Outstanding




Bed Bath & Beyond’s quick ratio stands at 1.6, has averaged 1.0 over the last decade, and

bottomed at 0.5 in 2007. The quick ratio compared to the current ratio reflects Bed Bath

& Beyond’s high amount of inventory. Since quick ratios of American companies

average near 0.5, it appears that Bed Bath & Beyond is relatively safe from this

perspective as well. Taken together, this indicates that Bed Bath & Beyond has very low

short-term liquidity risk.


Working Capital Turnover Analysis

As shown in the chart below, Bed Bath & Beyond’s working capital turnover ratios have

been fairly stable over the last decade. BBBY does not report accounts receivable

because all of its customers pay with cash, check, or credit card, which is all considered

cash or cash equivalents. Hence, it is not possible to show Days Sales Outstanding.

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

Figure 18: BBBY's Current Ratio

0.0

0.5

1.0

1.5

2.0

Figure 19: BBBY's Quick Ratio



The bargaining power of Bed Bath & Beyond’s suppliers is evident here. With

approximately 50 Days Payable Outstanding on average and nearly 150 Day Sales of

Inventory, Bed Bath & Beyond faces some risk in paying its suppliers on time. However,

with over $1.8 billion in cash and marketable securities, this risk to BBBY does not

appear to be large.


Bankruptcy Risk

Using Altman’s Z-Score to analyze Bed Bath & Beyond’s bankruptcy risk, the firm

appears to be at low risk for bankruptcy, with a current Z-score of 8.6 and a consistent Z-

score above 6 over the past decade.


-100

-50

0

50

100

150

200

Figure 20: Days Financing Required

BBBY's Day Sales of Inventory BBBY's Days Payable Outstanding

0

2

4

6

8

10

12

14

16

18

Figure 21: BBBY's Z-score



Future Potential for Leverage

Given our analysis, Bed Bath & Beyond could easily take on debt in the future. Bed Bath

& Beyond could benefit from the debt tax shield and lower overall cost of capital, since

its cost of debt would be lower than its cost of equity given its current capital structure.

With a low risk of bankruptcy and consistent positive operating income, Bed Bath &

Beyond could meet regular interest payments. Additionally, Bed Bath & Beyond likely

has adequate collateral for debt financing.

VALUATION

Discounted Cash Flow (DCF) Valuation

Discounted cash flow analysis is one of the primary methods that analysts use to value

companies. There are different ways to approach DCF analysis, but we have chosen to

use the “operating cash flow add-back method,” which starts with operating cash flow

and adds/subtracts out expenses that are related to or not related to the firm’s financing

decisions.

We obtained Bed Bath & Beyond’s equity beta from Bloomberg, which uses a weekly

interval for measuring the covariance between the performance of the broader stock

market and Bed Bath & Beyond’s stock. According to Bloomberg, Bed Bath & Beyond’s

equity beta was approximately 1.09. This is intuitive because Bed Bath & Beyond is in

the business of consumer durables, and therefore, the firm’s stock performance should

closely track the market at-large.

Since Bed Bath & Beyond has historically had little debt on its balance sheet and has not

demonstrated an intention to issue significant debt in the near future, the firm’s Weighted

Average Cost of Capital (WACC) equals its cost of equity. We derive the cost of equity

using the Capital Asset Pricing Model (CAPM). We use the 30-year U.S. Treasury rate of

3.14% and an equity risk (market) premium of 5.00% based on the consensus of analysts’

opinions. With a beta of 1.09, the CAPM results in a WACC of 8.59% for Bed Bath &

Beyond.

After determining the firm’s weighted average cost of capital, we apply the discount rate

to the cash flows generated by Bed Bath & Beyond’s business operations. We begin with

Cash Flow from Operations and subtract capital expenditures to derive company-level

Free Cash Flow. We have assumed an effective tax rate of 39%, the tax rate in FY2010.

Having completed this, we assume a 2% terminal growth rate (at or below expected U.S.

GDP growth) to estimate terminal value, discount all cash flows at the WACC and add

back excess cash, which we defined as cash and short-term marketable securities. Since

the latest 10K was published for FY 2010 last year, we estimated equity value per share

using the share price and number of shares outstanding both from February 2011, when

the 10K was issued and those same quantities from April 2012. During the time period

between February 2011 and April 2012, shares outstanding declined by nearly 20 million



as a result of share buyback, while the stock price rose 45% from $47.85 in February

2011 to the current share price of $69.41 (as of April 13, 2012). We find that the equity

value per share as of February 2011 using our model is $64.33, while as of April 2012 it

is $69.92. Given the current share price of $69.41, our model would suggest that Bed

Bath & Beyond is correctly valued today, and we would be inclined by the DCF to place

a “hold” rating on the stock. However, since we drive our model based only on FY2010

numbers and no new information, from the perspective of February 2011, our analysis

would suggest that BBBY was undervalued at a share price of $47.85. We see from

BBBY’s stock performance over the last year that the market agreed with this sentiment

Table 7: Discounted Cash Flow Analysis (in millions of dollars)

2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Cash Flow from Operations 987

956

1,014

1,066

1,123

1,183

1,248

1,316

1,388

1,465

1,546

Less CapEx (183) (188) (198) (209) (221) (234) (247) (261) (275) (291) (307)

FCF for All Stakeholders

804

768

815

857

902

950

1,001

1,055

1,113

1,174

1,239

Discount Factor

1.09

1.18

1.28

1.39

1.51

1.64

1.78

1.93

2.10

2.28

PV (FCF)

707

691

669

649

629

610

593

576

559

543

Terminal Value

8,247

Enterprise Value 14,474

Less Debt -

Plus Excess Cash 1,884

Equity Value 16,358

Shares Outstanding Feb 2011 254.3

Shares Outstanding April 2012 234.0

Equity Value per Share - Feb 2011 $ 64.33

Equity Value per Share - April 2012 $ 69.92

Residual Income Valuation

Our second valuation method is the residual income method that values BBBY by adding

the present value of excess returns earned by the firm over its required return on equity to

the current book value.

The main challenge we faced in conducting a residual income valuation was determining

the assumptions for cash management. Without returning cash to investors, Bed Bath &

Beyond’s cash reserves would exceed $8 billion by 2020, which would be unnecessarily

high, as cash alone would represent 68% of total assets as opposed to 21% today. Bed

Bath & Beyond does not have much use for this much cash, other than perhaps using it to

make an acquisition. A more likely scenario is that Bed Bath & Beyond returns cash to

investors through dividends or share repurchases. Historically, Bed Bath & Beyond has

not paid dividends and has done relatively minimal share buyback programs. Since we



cannot predict which method (share buybacks or dividends) Bed Bath & Beyond will

implement, we grouped share repurchases and potential dividends together in our cash

flow from financing. We took the amount of cash Bed Bath & Beyond returned to

investors in the form of share buybacks in FY2010 and grew that amount by 5% annually

until 2020. This is approximately the rate at which net income grows in our forecast.

(Confirming our assumptions from the perspective of FY2010, Bed Bath & Beyond did

in fact announce a share buyback program in Q3 2011).

Having determined the value of BBBY’s residual income (net income minus required

earnings, based on the firm’s total assets and cost of equity), we discounted at the firm’s

8.59% cost of equity. Assuming the same 2% terminal growth rate, we obtain a per-share

valuation for Bed Bath & Beyond of $51.41 from the perspective of February 2011 and

$55.88 from the perspective of April 2012 (see the DCF section for a discussion of why

we looked at both time periods). This would suggest that Bed Bath & Beyond is

overvalued today at a share price of $69.41, and we would be inclined to put a “sell”

rating on the stock based upon this valuation method.

Table 8: Residual Income Analysis (in millions of dollars)

2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Beginning Book Value

5,932

6,147

6,379

6,629

6,898

7,187

7,499

7,834

8,194

8,581

Cost of Equity 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09

Required Earnings

510

528

548

569

593

647

675

705

737

772

Net Income

854

902

953

1,006

1,063

1,122

1,185

1,252

1,322

1,397

Less Required Earnings

(510)

(528)

(548)

(569)

(593)

(647)

(675)

(705)

(737)

(772)

Residual Earnings

344

374

405

437

470

475

510

547

585

624

Discount Factor

1.09

1.18

1.28

1.39

1.51

1.64

1.78

1.93

2.10

2.28

PV (Residual Income)

317

317

316

314

311

290

287

283

279

274

TV (Residual Income) 4,155

Total Residual Income

7,142

Calculated Book Value

13,074

Shares Outstanding - Feb 2011 254

Shares Outstanding - April 2012

234

Equity Value Per Share - Feb 2011 $51.41

Equity Value Per Share - April 2012 $55.88

Relative Valuation

Another common method of valuation is the analysis of comparable companies, which

benchmarks a company’s valuation against similar companies. Our peer group consists of

other publicly traded home furnishings retailers with similar business models. We find



that Bed Bath & Beyond is in-line with the industry average enterprise value to earnings

before interest, taxes, depreciation, and amortization multiple (EV/EBITDA) with a

multiple of 7.4x and is in-line with the industry average adjusted/pro-forma price to

earnings ratio with a multiple of 17.3x. Our findings support a “hold” rating for BBBY.

Table 9: Relative Valuation

Company Ticker Enterprise Value EV/EBITDA Pro Forma P/E

Bed Bath & Beyond BBBY $12,959,206 7.4x 17.3x

Williams Sonoma WSM $3,238,126 6.3x 16.9x

Pier One PIR $1,602,204 8.1x 11.7x

Cost Plus CPWM $426,225 8.3x 23.7x

Average 7.5x 17.4x

Source: Bloomberg

Documents

A Financial Analysis and Valuation of Bed Bath & Beyond · BBBY has marginal negotiating power with its suppliers. Although BBBY has developed strong relationships with select suppliers,