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There’s little value in rehashing the finer points of yet another solid quarter from Bed Bath and Beyond.  Let’s be upfront and recognize that the opportunities ahead have very little to do with the past.  At least that’s the sense I get after talking with numerous investors over the past week.  So putting aside the above-expectation and above-plan same-store sales, the near $1.6 billion in cash on the debt free balance sheet, and the guidance which remains unchanged (and still conservative), the market seems to have made up its mind that this is as good as it gets.  At the same time, this also appears to be the sentiment towards most retailers.  And, perhaps this is fair given the optics ahead.  There’s no question that same-store sales will slow as the company butts up against more challenging compares beginning on Q3.  The same holds true for inventory management, which showed a tick down in its spread relative to sales and is no longer being cut at the same rate.  We knew the day of tougher comparisons on the horizon would come and we’re now one quarter away.  But, what’s new?

Despite what may be a near-term disconnect between tomorrow’s expectations and those in the intermediate term, we still believe there is ample opportunity for earnings to exceed expectations over the remainder of the year and into next for BBBY.  The key here is recognizing that EBIT margins are still about 100 bps off peak in an environment that is less competitive, has far less capacity, and is not overshadowed by aggressive promotional activity (i.e couponing).  We believe the company is almost half way through the process of unwinding the heavy use of direct-mail coupons and coupon inserts that were very much a part of a three-year trend in gross margin erosion.  At the same time, square footage growth remains a healthy 5% and the likelihood for additional share repurchases remains high.

Finally, a point about the elephant in the room, a.k.a sell-side concerns about a slowing topline coming into the earnings print.  There was absolutely no evidence in our view on the conference call to  suggest that sales have slowed.  The guidance for 2Q same-store sales stands at a mid-single digit increase.  Recall that guidance has called for a mid single digit increase since the end of 3Q09.  The question will be is this the “real” expectation, or is this a case of subtle conservatism?  We believe it’s more likely the latter.

Our view remains unchanged on the opportunities that still lie ahead for the shares.  We still believe earnings will grow by at least 25% for the year.  This is now the fourth quarter in a row in which gross margins have improved, after 10 quarters of declines.  We can’t fight a growing level of bearishness permeating the retail space, but we can and do remain objective on the fundamental opportunities that still exist for the shares.

BBBY: Subtle Conservatism - 6 23 2010 6 39 07 PM

Eric Levine

Director