BBBY: Sales…check…GM’s…check…SG&A Control…check…Cash…check

BBBY reported 2Q EPS of $0.52, well ahead of the Street which was looking for $0.47.  Our model was actually forecasting $0.53 (we had a slightly lower share count).  The magnitude of the upside is noteworthy but the composition and consistency of BBBY’s steadily improving results is even more impressive.  Once again, the upside in the quarter came across all three line items. 

 

First, same store sales came in at down 0.6%, about 60 bps ahead of the Street.  Whispers were as high as 3%.  If you were trading the stock long into the quarter, then we can see how you might be disappointed.   However, at a near flat same store sales result, the company is well on its way towards positive comps over the next couple of quarters.  Trading sentiment aside (which will only last for about a day!), the topline is still a relative outperformer across much of retail and certainly sufficient to drive earnings growth (proven for the second straight quarter). 

 

Gross margins were much better than expected, actually UP 51 bps year over year.  This is the first positive gross margin result since the third quarter of 2006! I continue to believe this is only the beginning of margin recovery resulting from a substantially more benign promotional environment, a less competitive marketplace, and tight inventory control.  Management noted that product acquisition costs were also favorable which helped to drive the improved profitability.   Recall that Linens’ heavy couponing began long before the end of 2008 as the company attempted to drive sales as the ship was slowly sinking.

 

SG&A expense was better as well, with the expense ratio down 98 bps.  We were modeling a 170 bps decline, but instead results were more balanced between margins and expenses. SG&A dollars were essentially flat with last year.  We expect expense improvement to moderate, however leverage will begin to build as sales growth continues accelerates.  Additionally, reduced levels of direct mailings will continue to be a source of expense reduction over the next few quarters.

 

Finally, the balance sheet was solid with inventories down just over 3%, against total sales that grew by 3%.  Still no debt and a growing cash balance that now totals $1.2 billion (up $450 million from 1Q).  Share repurchase was barely noticeable (more of a token purchase) with the company buying back $20 million in the quarter.  There is close to $900 million remaining under the current buyback plan and I suspect repurchase activity will pick up in the coming quarters.

 

From here, it’s steady as she goes.  We should continue to expect the comp trend to turn positive in 3Q, gross margin expansion (after 10 quarters of declines), expense leverage, and earnings growth of at least 17% for 3Q and 20+% in 4Q.  Throw some more meaningful share repurchase on top and the numbers will move higher.

 

I know this is getting repetitive but the bottom line here is this was another solid quarter and BBBY now begins to anniversary easier sales comparisons.   Additionally, while the downturn in home furnishings, subsequent Linens N’ Things liquidation, and industry consolidation took place over a multi year period, so too will the recovery.   So what’s the bear case? Valuation is the most common pushback along with many investors saying, “I missed it”.  Six months from now we’ll be looking back and the stock will be higher. 

 

And, by the way this is one of the best looking SIGMA charts in all of retail…

 

 

BBBY: Sales…check…GM’s…check…SG&A Control…check…Cash…check - BBBY 9 09


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