Bed Bath & Beyond: Little Value With Possibility Of Bankruptcy (NASDAQ:BBBY)

Bed Bath and Beyond store facade in red

krblokhin

Introduction

My favorite fantasy corporate merger of 2022 would be that of Bed Bath & Beyond (NASDAQ:BBBY) (YTD losses: $724 million) and Beyond Meat (BYND) (YTD losses: $198 million). Bed Bath & Beyond Meat would sell plant-based protein along with home furnishings to a dwindling customer base. In my opinion, the synergies may not be immediate, but down the line, you would need to pay only one set of bankruptcy lawyers.

Coming back to the real world, BBBY reported quarterly earnings this morning.

Bed Bath & Beyond Q2 financial overview

For the latest quarter ending August 27, 2022, the company generated $1.4 billion in revenue, down 27% YoY. Operating income was a loss of $346 million (-24% operating margin), and net income was a loss of $366 million or $4.59 per share.

The company currently has 80 million shares and a market capitalization of $500 million. It has $1.7 billion of debt and $0.1 billion of cash for net debt of $1.6 billion. It thus has an enterprise value of $2.1 billion, amounting to 0.3x its annual revenue.

Although the company cleared some inventory by discounting this quarter, it still remains uncomfortably high at 4.5 months of sales. Shockingly, the company continues to invest in capex ($122 million) in excess of depreciation ($71 million). This may be a sign that it is aggressively capitalizing expenses.

Analysts expect the company’s revenues to stabilize next year, with continuing losses. The company has not offered a credible path to profitability and is focused on raising cash to fund its operations.

The company missed a golden opportunity to issue hundreds of millions of dollars worth of stock in the short-lived meme frenzy in August when its stock went up to $30. Clearly, management seemed asleep at the switch on their 1,000 thread count sheets (pro tip: thread count is not everything. Above 500, there really is no benefit). But issue stock they did not, while meme lord Ryan Cohen took the opportunity to dump his stake in the company. Weeks later, after the stock had come back down to earth, they arose from their slumber and decided to do an at-the-market offering. To date, the company has sold 3 million of the 12 million shares planned to be sold.

BBBY stock valuation

Sadly, I believe the chances of a turnaround here are minimal. I expect losses to continue and a debt default at some point. The company has bonds due in 2024 and will try to refinance them with new debt or equity. If it is unable to do so, a bankruptcy filing will be necessary, rendering the shares worthless.

In a bull case, the company would be able to generate a 2% margin on $6 billion of annual revenue for annual operating income of $120 million a year. After interest expense of $70 million a year, $50 million would be left for shareholders. The company could use its accumulated losses to shield taxes, resulting in earnings per share of $0.60 per share. A 15x multiple on this would result in fair value of $9 per share for 30% upside from the current share price of $6.80.

Short interest and cost of borrow

I would not recommend shorting a stock that already has a high short interest, with the possibility of a short squeeze driving the price much higher. It would also not be economical to pay an exorbitant borrow cost that potentially eats up all the downside on the stock side.

BBBY has a high short interest at 38% of outstanding shares. The stock is hard to borrow with a borrow cost of 13% a year, although your broker may charge a different rate. This certainly eats into any profit you may realize on a short position with the stock coming down.

Recommendation

I recommend that investors avoid buying the stock and sell any holdings. For those who want to take the other side, rather than shorting the stock, I recommend selling calls on it to generate income. The $15 strike December calls can fetch you $0.50. Keep in mind that these can result in large mark-to-market losses if the stock spikes. The risk is somewhat lessened by the company being in the market selling its shares.

External ratings

Seeking Alpha’s quant rating is surprisingly positive on the company. It has a composite rating of 3.07, equating to a hold. It garners an A+ for valuation and an A for growth. On digging deeper, it appears that the valuation grade is because the company has a low EV/Sales ratio, while the profitability metrics are blanked out (possibly because they are negative, but this should not be the case). The growth grade is harder to understand, with a couple of F factor grades, a D and a B for capex growth resulting in an A for the total.

Wall Street analysts are more negative, with a combined rating of 1.76, equating to a sell. Their price targets have been following the stock lower.

Risks are moderate and manageable

Shorting stocks and selling naked calls is inherently risky, since the potential losses are theoretically infinite. I would recommend shorting stocks only when paired with a long portfolio.

There is always a possibility of a short squeeze driving the stock higher. However, with interest rates going higher, I would regard the chances of this happening on an extended basis to not be very high.

At a $0.5 billion market cap, an acquisition by another company or private equity is certainly feasible, but an acquirer will need to take on large operating losses.

The gap between the company’s intrinsic value and share price could widen over time.

The company’s operations could improve dramatically to the extent that it starts generating huge profits.

Pre-emptive disclosure

Writing a short thesis on a stock on a public forum is an invitation for blowback from employees and holders of the stock. I welcome respectful comments from eponymous readers. If you are a holder or employee, you would be better off directing your energies towards having your company become profitable.

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