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So here’s the setup on BBBY.  I’m at $0.67 for the quarter, Street is at $0.63 (high-end of guidance).  I’m modeling a 5% comp and modest gross margin expansion.  This represents the first quarter that the company comes up against gross margin gains on y/y basis.  Importantly, I believe they can achieve margin expansion given ’07 and ’08 saw massive margin erosion in the wake of the housing blow up and substantially heightened promotional activity. 

The environment over the past few months has been very much status quo from a promotional standpoint (we’re not talking denim or logo tees here) as well as a demand perspective.  WSM, PIR, KSS, TGT, COST, and TJX all continued to highlight home/soft home as a leading category (i.e actually comping positive), which is consistent with the commentary we’ve been accustomed to hearing over the past 6 months.  Overall there remains substantially less couponing by BBBY a key factor in maintaining margin expansion.

With the fundamentals sound, the sentiment is a bit different heading into the quarter this time vs. last.  Recall,  there was much speculation last quarter surrounding a same store sales miss heading into the print.  BBBY ultimately came through with the top line, although there was substantial volatility into the reporting of results and the shares sold off even with confirmation that sales didn’t tank. 

This time the set-up is more benign, as we haven’t heard many whispers going into tomorrow evening.  The flip side here is the stock is at $42 (almost parity with June 23rd, the date of the last quarterly release) but the environment is slightly more positive towards the space (we can’t ignore the S&P’s 8.8% increase month to date as one of the more positive backdrops).  All in, this quarter largely hinges on guidance for the next quarter and the year.  The Street is currently at the upper end of this quarter’s guidance, but ahead for the remainder of the year.  Like most of retail, the rest of the year that presents the greatest challenge on both top and bottom line comparisons.  We’re concerned that the 19% growth represented by the consensus is very unlikely to be blessed by management.  Yes there is still upside here on the margin line, but you won’t know it come tomorrow’s recorded conference call.  Headlines will run with a “guide down”  spin even if we all know that this management team is one of the most conservative in all of retail. 

Yes, we’d all like to believe all of this conservatism and tough comparison rhetoric is “in the stock”.  However, this is easier said than done and we wouldn’t be surprised to see a sell off even if the underlying prospects remain solid for BBBY.  For the longer term, we’re still comfortable that margins can continue to expand and that cash will either continue to build or eventually be deployed. 

The wildcard remains share repurchase, which management has been very conservative with despite sitting on $1.6 billion in cash and no debt.  This can only mean upside, but we put less than a 50% chance that they stepped it up in a meaningful way.  BBBY is still one of the better retailers out there, with a decidedly favorable competitive position.  We’re just not confident that the stock is well positioned from the long side (come tonight’s results).

BBBY: Facing Reality - bbby2q

Eric Levine

Director