BBBY: Showing Some Risky TAIL

BBBY showed its TAIL risk after the close with comps decelerating nearly 400bps sequentially, producing the greatest negative deviation relative to our home furnishings index we’ve seen since its inception. On top of 2 non-core acquisitions over a 1 month time period this is a complete validation of every concern we’ve had for BBBY.


Our Home furnishings index, which we use as a leading indicator for BBBY comps, implied a +6.5% comp. The +3% print was simply a massive miss. Our model is based in large part on Personal Consumption and Retail Sales for different home goods products. It’s proven to be extremely accurate over time, with a 0.75x correlation, and if you ex-out the period when it was putting Linens ‘n Things out of business (and posted outsized comps) the correlation is closer to 0.90x. Directionally, something went very wrong this quarter.  Yes, there’s definitely the on-line share loss factor , but it’s also no mistake that this is happening in conjunction with BBBY’s headquarter move. The margin of error there is too great to ignore – especially with the company integrating two acquisitions.


We’ve remained negative on the intermediate term TREND and long term TAIL and are reiterating our stance. Consider the Following:


  • After adjusting for the $0.06 tax benefit, BBBY 1Q12 EPS came in a penny below expectations driven by light revenue growth (+5.1% vs. +6.4E) and weak gross margins (-65bps vs. -25E)
  • The Gross Margin decline in the quarter was driven by both an increase in coupon redemptions & redemption amount as well as the continued shift to lower margin product categories. In light of BBBY citing AUR as a driver of the +3% comps, the shift to lower margin product categories suggests the pricing mix may also be shifting upwards, driving a greater coupon redemption dollar amount. Notably, per our in store AMZN/BBBY sku overlap analysis (see chart below), AMZN has 10-15% lower prices in higher ASP product categories suggesting a shift to higher price point categories could keep BBBY at risk of additional couponing or online attrition pressuring margins further.
  • The sales to inventory spread declined 5 points sequentially to -1% in Q1 after having popped into positive territory last quarter. This creates a somewhat bearish gross margin setup over the intermediate term TREND especially given the incremental coupon use at a time when PIR highlighted a balance in full price and promotional selling with no major negative change in the discounting environment relative to last year.
  • BBBY said that it remains focused on enhancing its omni channel experience and expects its new 800,000 square foot e-commerce fulfillment center to be operational in 2H12. Today, e-commerce accounts for ~1% of total sales and has been declining over the past 3 years. Customer demographics continue to be a key issue here. 65% of BBBY’s current online consumers are above the age of 35. Industry data suggests that BBBY’s exposure to the 55 & up demographic increased nearly 300bps in 2011 vs. 2010 to 26% putting BBBY 9th in terms of the most exposed to the older demographic relative to the 95 companies we’ve analyzed. It is nearly impossible for e-commerce to really gain traction without investing and while not a direct comp, WSM’s omni channel model currently boasts e-commerce nearing 40% of sales.
  • Although BBBY reiterated its full year EPS growth of HSD-LDD and comp of +2-4%, operating margins are now expected to be down vs. flat to down slightly previously. Despite the net negative change in outlook on the margin, this still seems aggressive. At a minimum, it seems like the time where we can all give them a free pass on beating guidance is gone.
  • BBBY has leveraged operating expenses nearly 200bps over each of the last 3 years with operating expenses up only ~1% in Q1 and down 2.2% on a per square foot basis. BBBY had originally guided advertising activities to remain flat in F12 however if BBBY expects a reacceleration in the business and traction online, they will have to spend to get it.

We remain bearish here – not because of what happened, but because of what the quarter and recent strategic actions signify. The company’s model remains exposed to the online threat (with a 93% direct sku overlap with with its competitive advantage remaining in its in-store experience. Though it seems demand is slowing (per our Home Furnishings Index below) BBBY’s current share is slipping for the first time in many years -- which will require incremental investments back into the business following 3 years of opex leverage. Not good with BBBY sitting at peak ~17% operating margins. We remain negative on the long term TAIL call here. 


Matt Darula



BBBY: Showing Some Risky TAIL - BBBY comp index


BBBY: Showing Some Risky TAIL - AMZN BBBY pricing


BBBY: Showing Some Risky TAIL - BBBY SIGMA

HedgeyeRetail Visual: H&M European Reacceleration?


We’re surprised by the sequential improvement in trend line sales by country at H&M through Q2. It’s notable to us that the only major countries H&M serves that are incrementally trending down on the margin are the US as well as Sweden. While none of H&M’s second tier countries are knocking  the cover off the ball – i.e. all up less than 5% on a 2-year run-rate – they’re all running up sequentially except for the Netherlands (5% of sales). The company also noted that 2Q markdown activity was unchanged vs. last year confirming that aforementioned sales were not discount driven – an incremental positive re ongoing concern over European demand.


HedgeyeRetail Visual: H&M European Reacceleration? - HM sales by country


HedgeyeRetail Visual: H&M European Reacceleration? - top countries


HedgeyeRetail Visual: H&M European Reacceleration? - 2nd tier 

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.


Discover Financial Services (DFS) has been a darling for the market over the last several quarters. Between improving credit and the ability to return capital, the company at face value looks very solid.


Behind the curtain, however, are issues that raise concerns. So much so that Hedgeye Financials Sector Head Josh Steiner has immediately gone bearish on TRADE, TREND and TAIL durations. Steiner has effectively found four main issues with the company and the stock that make his case clear:


  • Peak earnings on what is now a peak multiple. When everything is going right, it’s usually not long before something goes wrong.
  • We see 18% downside just from mean reversion, and that incorporates no credit quality deterioration.
  • Volume slowdowns precede credit slowdowns. We’re seeing evidence on multiple fronts now that volume growth is decelerating.
  • Sentiment on DFS is uber-bullish. Not one sell rating among 26 analysts (19 buys / 7 holds) and short interest in its bottom quintile since coming public.

So while the banks and sellside analysts remain primarily bullish on DFS, Steiner continues to stand contrarian. It appears that the good times can only roll for so long before something goes wrong.





investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.