This note was originally published May 09, 2012 at 10:31 in Retail
This one is ominous. After three years of benefitting from a competitor’s demise, BBBY’s organic growth rate is slowing due to secular and cyclical forces. So what does it do? Buys something 3x larger than any other deal it’s done. Good luck.
Congratulations BBBY, you just made it a notch higher on our short list. Seriously…Cost Plus? What’s next, Big Lots? Shopping rule number 1… Just because you could get something cheap it does not mean you should buy it. With your $515mm purchase of CPWM, you get an extra $1bn in revenue, including $400mm in consumables (something you do almost none of today). This is a different animal altogether. Translation = you have a healthy, 16% EBIT margin business today, and you just bought something that struggles to keep up even the hope of getting to a 5% margin.
Asset turns higher at CPWM (therefore offsetting low margins to keep returns high – a la Costco and Sam’s). Yes. But we’re talking 2.65x asset turns vs 1.67 for BBBY. COST runs at 3.50, and BJ runs at 4.85.
As for timing, BBBY is running against some obvious secular challenges with internet competition, and is also facing tough compares as it relates to where it is in its cycle. Driven by mid-to-high single digit comps upon lsd square footage growth over the past 3-years, operating profit grew 46%, 31%, and 22% in 2009, 2010, and 2011, respectively. Many people forget that this is the precise period after which Linens and Things went bankrupt. Since then, EBIT growth has eroded sequentially, Amazon has come on hard, and the company has taken evasive maneuvers to streamline its operations – including relocating its headquarters by 50 miles (causing a potential talent retention problem).
The bottom line here is that this business needs to be fixed. And fixed in a pretty meaningful way. BBBY has done acquisitions in the past, and has ‘fixed’ them to an extent. But lets keep the numbers in context. Each of its prior three acquisitions accounted for less than 30 stores – or 7% of BBBY’s existing size – at the time of acquisition. Cost Plus equals 22%. This is a major statement by the company that it has to move further outside its (extremely profitable) core to continue to deliver the growth that it’s multiple deserves.
We don’t like it one bit.
Fast Facts About Cost Plus:
Cost plus is a specialty retailer of casual home furnishings and entertaining products in US. They currently operate 258 stores in 30 states under the names “World Market”, “Cost Plus World Market” and “World Market Stores”. The company’s strategy is to differentiate itself by boasting a largely unique, ever-changing selection (many of which are imported) at value prices in an exciting shopping environment. A large portion of products are proprietary or private label. The “World Market” brand is typically not available in department stores or other specialty retailers. One of the primary differences between BBBY & CPWM is that 40% of CPWM sales are in consumables with the remaining 60% in home furnishings. Additionally, within home furnishings, CPWM offers ready to assemble living room/dining room pieces as well as sofas, chairs, as well as outdoor furniture.
Home Furnishings: Furniture, rugs, pillows, bath linens, lighting, window coverings, frames, and baskets. Furniture products include ready-to-assemble living and dining room pieces; sofas, chairs; unique handcrafted case goods and occasional pieces; as well as outdoor furniture made from a variety of materials.
Consumables: Gourmet foods and beverages, including wine, microbrewed and imported beer, coffee, tea, and mineral water. The wine assortment offers a number of moderately priced premium wines. Foods generally have a shelf life of 6 months or longer.
Stores (generally 15,700 square feet) are designed to evoke a “marketplace” feeling. The company feels its stores are a destination store with a specific purchase in mind (largely similar to BBBY).
Online sales currently represent ~3% of sales (www.worldmarket.com).
The Company purchases its merchandise from approximately 2,000 suppliers; the largest of which represented approximately 3% of total purchases in the fiscal year ended January 28, 2012. A significant portion of Cost Plus World Market’s products are manufactured abroad in over 50 countries in Europe, North and South America, Asia, Africa and Australia.
Net sales were $964mm in 2011 at an 32% GM and 3.3% operating margin.