Why Bed Bath & Beyond's Margins Could be Strained in FY18

Bed Bath & Beyond Inc. BBBY has been struggling with weak margins for quite some time now, which has been taking a toll on its performance and hurting profitability. Apparently, the company’s top and bottom-line has lagged estimates in four of last seven quarters. Unfortunately, the strained margins trend is anticipated to linger in the days ahead.

These have hurt investors’ sentiments, as shares of the Zacks Rank #5 (Strong Sell) plunged 55.3% in a year, much wider than its industry’s 17.5% decline. In fact, the stock lost 18.7% after it reported fourth-quarter fiscal 2017 results on Apr 11. Consequently, analysts are becoming increasingly bearish on the stock. Further, it has witnessed downward revisions in its earnings estimates.

Let’s Delve Deep into BBBY’s Margin Issues

Bed Bath & Beyond has been witnessing soft gross margins for seven straight quarters now. Higher direct-to-customer shipping expense, lower merchandise margin as well as a rise in coupon expense on account of increased redemptions and increase in average coupon amount has been marring the company’s gross margin. It contracted 210 basis points (bps) in the fourth quarter followed by declines of 180 bps, 100 bps and 90 bps, respectively, in the third, second and first quarters of fiscal 2017. Moreover, the company witnessed gross margin decline of 60 bps, 80 bps and 70 bps in the fourth, third and second quarters of fiscal 2016, respectively. Lower gross margin along with higher selling, general and administrative (SG&A) expenses led the operating margin to decrease 310 bps year over year in the fiscal fourth quarter.

In fiscal 2018 also, the seven-quarter long trend will persist as management expects gross margin to decline owing to continued investment in the customer value proposition and the constant shift to the digital channels. Further, SG&A is estimated to increase on account of investments toward transformation. As a result, the company expects operating margin to decline in the fiscal, however, lower than that in fiscal 2017.

Why Estimates Saw Downtrend Post Q4 Earnings?

Bed Bath & Beyond has witnessed huge downward revisions in its earnings estimates lately. This is mainly attributed to the company’s bleak outlook for fiscal 2018. Apart from expecting soft margins, the company provided a weak sales, comparable store sales (comps) and earnings view for fiscal 2018.

The company expects consolidated net sales to remain relatively flat to marginally up year over year, with comps likely to increase in the low-single digit percentage range. Management envisions fiscal 2018 earnings per share to be in the low-to-mid $2 range, down from $3.12 earned in fiscal 2017.

Consequently, the Zacks Consensus Estimate of $2.36 for fiscal 2018 and $2.02 for fiscal 2019 moved south by 38 cents and 56 cents, respectively, in the last seven days. Also, the consensus estimate of 33 cents for the first quarter of fiscal 2018 went down by 13 cents.

BBBY’s Plans to Revive Margins

Bed Bath & Beyond has been resorting to various transformation efforts to become the customers’ first preference. To this end, the company is focused on improving operational efficiency, which includes transformation of information technology group and related business processes to meet consumers’ evolving demand. Also, it has set up a strategic portfolio management office (“SPMO”) to allocate resources toward more profitable areas. Through the SPMO, the company is creating an integrated portfolio of strategies to improve gross margin, optimize inventory levels, enhance supply chain and implement customer service transformation. Additionally, the company is undertaking several customer-centric plans like enriching product assortment, improving services and providing a more seamless experience to customers.

Though management at Bed Bath & Beyond is taking strict measures to aid a turnaround, margin performance in particular, will take time.

Other Stocks Witnessing Margin Constraints

Apart from Bed Bath & Beyond, there are retailers namely DICK’S Sporting Goods Inc. DKS, Abercrombie & Fitch Company ANF and Ross Stores Inc. ROST struggling with strained margins.

DICK’S Sporting is witnessing margin pressures mainly owing to lower sales and higher promotions. Going ahead, management anticipates greater product innovation from its key partners and further expansion of its private brands business to lower margin pressures than previously guided. Nonetheless, it still expects margins to remain under pressure.

Abercrombie is grappling with weak margins due to soft traffic at its stores. Additionally, the company’s ongoing strategic initiatives to enhance profitability have been denting its margins, which is likely to remain under pressure in first-quarter fiscal 2018.

Ross Stores envisions soft operating margin for the first quarter and fiscal 2018 owing to flat merchandise margin and, the impact of competitive wage and benefit-related investments.

All three stocks carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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