The lessons of Bed Bath & Beyond – and why we’re taking a pass on its super-volatile stock

Published January 12, 2023

Bed Bath & Beyond Inc. could be headed for bankruptcy. That offers investors many cautionary lessons.

From its IPO in the early 1990s to roughly 2014, BBBY was a market darling and a retail juggernaut. The organization was profitable, with an expanding top line and generally rising comparable store sales. True to its name, their product assortment went well beyond bed and bathroom items, and shoppers liked the store concept. The balance sheet was strong, the store base was growing, and the brand was well recognized. The stock price reflected this success, peaking at over US$80 in 2013.

However, retail is tough. By 2018, the name had fallen from grace and landed on our watch list here at Contra the Heard Investment Newsletter. At the time, revenues and same-store sales were starting to falter, but it was still profitable, with a good balance sheet and low valuation. Despite the positives, though, we never took a position – insider selling, a questionable game plan and a negative outlook were nagging issues. Moreover, most quarterly reports from that point only got worse. Sales began to decline sharply, big net losses appeared and leverage jumped. While we continued to watch the name, it looked like a value trap.

In 2019, things got super messy. Activist investors got involved, the CEO was shown the door and the corporation entered a rudderless phase just as the pandemic hit. Though the shares rebounded sharply in late 2020 and it became a meme stock in 2021, operational, inventory and supply chain problems mounted. In response, management accelerated store closings and layoffs, and these challenges caused the top line to contract further, losses to grow, and cash reserves to dry up. Instead of cutting debt and holding ample cash to increase the odds of survival, management and the board continued to go in the opposite direction, maintaining significant debt and using their precious cash to engage in large share repurchases. This buyback amounted to a huge gamble at a time when the firm needed to practice financial conservatism.

Today, the news flow around BBBY is fast and frenetic. The volatility is wild and reminiscent of the meme stock boom. The enterprise has warned of a possible bankruptcy, and failed to secure a debt swap with lenders. The latest quarter was terrible, with sales declining 33 per cent and a reported net loss of US$392.97-million, including a US$100.70-million non-cash charge. Layoffs and store closings continue, and inventory issues persist as suppliers pull back.

Though it could yet work out for Bed Bath & Beyond shareholders, the odds are not in their favour. The company could raise equity, but that would likely crush existing holders, and look outrageous to boot, given the scale of their previous repurchase plans. It could also secure a debt swap agreement with lenders, but that has already failed to materialize once, and at best would only buy time. A buyer could step forward at the last second, but this too appears unlikely. This is because a possible suitor would probably snag a better price by waiting until BBBY declares bankruptcy. Additionally, the bankruptcy proceedings – which will sort out the various claims over the corporation’s assets – will simplify life for any possible acquirer.

From our perspective, there are several lessons here. First, investor activism is not always a good thing – sometimes it distracts the C-suite and board, or forces changes that ultimately hurt the organization. In this case, the input from activists did nothing to help BBBY’s long-term viability.

Second, buybacks can help sink a company if the balance sheet carries significant debt and operational metrics are deteriorating. Instead of burning cash on buybacks, businesses in this position should be paying off debt and conserving cash.

Third, value traps are real. Often, they will have many of the following features: a shrinking balance sheet, high debt and/or low cash, a contracting top line, regular net losses, and a history of shareholder dilution. In the case of BBBY, most of these factors have been in play for years.

Fourth, some stocks are bad holds but represent great trading opportunities. BBBY’s stock chart illustrates this point. Over the past three years, the shares have trended lower, but have also had more than a half a dozen sharp rallies and reversals, thanks in large part to the meme stock craze. There are skilled traders out there who can play that game, but I am not one of them, and have never traded it.

Finally, turnarounds are hard – eliminating jobs, reducing store counts and cutting costs only go so far. For a turnaround to succeed, there must be a viable recovery plan in place to see that the operations expand once again and profitability returns.

Bed Bath & Beyond’s story today is fast-moving. The ticker is volatile, and the fundamentals are weak. So long as these characteristics are in play, BBBY will be speculative at best. For our part, we will be happy to watch this one from the sidelines; our best guess is that it will go bust.

Philip MacKellar is a writer for the Contra the Heard Investment Letter