Shares of struggling merchandise retailer Bed Bath & Beyond (NASDAQ:BBBY) soared on Tuesday, Mar. 26, after the Wall Street Journal reported that activist investors have targeted the stock for some major changes. BBBY stock popped more than 20% higher in response to the news.
Source: Mike Mozart via Flickr
Full disclosure, I’m not a big fan of chasing rallies. That’s particularly true with big rallies in BBBY. The last time the stock popped like this was in early 2019, following a bullish outlook from management in the Q3 earnings report. I said fade the rally. Over the next two months, BBBY rallied a bit more, but ultimately dropped more than 10%.
The same dynamic will play out this time around. BBBY stock is soaring on activist investor interest. But, there isn’t much activist investors can do to turn this sinking ship around. Revenues and margins are under pressure. The competitive landscape is only getting more intense.
Consumers don’t really have a need to shop at Bed Beth & Beyond over, say, Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT), or Wayfair (NYSE:W). Not to mention, there’s a mountain of debt sitting on the balance sheet, which basically serves as a ticking time bomb for this increasingly irrelevant retailer.
Overall, the chances of a turnaround here are slim. Yet, BBBY stock is being priced as if a turnaround is likely to happen. That disconnect means this big rally in BBBY stock should be faded.
A Turnaround Likely Won’t Happen
Investors are rushing into BBBY stock on the belief that three activist investors (Legion, Macellum, and Ancora) will be able to replace management, execute a new operational strategy, and successfully pull off a Bed Bath and Beyond turnaround.
To be clear, the likelihood of this happening is very, very slim. First off, the three activist investors together control around a 5% stake in Bed Bath & Beyond. That’s not nearly enough to get that excited about, and further implies that these activists have their work cut out in terms of doing what they want to do, which is replace the entire board and CEO.
Second, even if the activist investors are successful in replacing the board and CEO, the likelihood that these changes lead to a Bed Bath & Beyond turnaround is low. The harsh reality is that consumers don’t need Bed Bath & Beyond anymore. Essentially everything Bed Bath & Beyond sells, can be bought at Amazon, Walmart, or Target (NYSE:TGT), usually at lower prices and almost always with higher convenience (all three big retailers have significantly more robust omni-channel capabilities).
Amazon, Walmart, and Target also sell a host of other things like groceries, cosmetics, and clothing, meaning they offer one-stop-shop convenience which Bed Bath & Beyond critically lacks. They are also only getting bigger, more aggressively expanding into new product categories and building out faster and more effective omni-channel sales networks.
Thus, the need for consumers to go to a Bed Bath & Beyond versus a Walmart or Target is at an all time low, and only going lower. As it goes lower, it will become tougher and tougher for any management team to pull off a Bed Bath & Beyond turnaround.
The Valuation Is at Disconnect with Reality
At the present moment, Bed Bath & Beyond is suffering from a tri-fecta of headwinds. Sales are being challenged by eroding relevance and rising competition. Gross margins are dropping thanks to intense price competition. Opex rates are rising because the company is having to spend on marketing just to maintain tepid sales growth.
In order for BBBY to head higher from here, all three of those headwinds need to turn around. Specifically, sales growth needs to be consistently positive, gross margins have to recover, and opex rates have to start falling.
If all that happens, Bed Bath & Beyond could be looking at $3 in EPS by fiscal 2023. Based on a historically average 10 forward multiple, that equates to a fiscal 2022 price target of $30. Discounted back by 10% per year, that implies a fiscal 2018 price target of $20.
Thus, if a big Bed Bath & Beyond turnaround does materialize, this stock has upside to $20 over the next few months.
But, the odds of that turnaround happening are small, given that the retailer’s competitive challenges are only growing with time. As such, a far more likely outcome for sales and margins over the next several years is that they continue to be pressured by rising competition and falling relevancy. In that more likely scenario, EPS pans out around $2 in five years. Using the same math above, that implies a fiscal 2018 price target of $13.50.
As of this writing, BBBY stock is trading at the midpoint of those two potential price targets, implying each scenario has equal probability. They don’t. The $13.50 price target has far higher probability than the $20 price target. As such, prices on the high side of $15 today seem too high.
Bottom Line on BBBY Stock
If Bed Bath & Beyond does manage to turn things around, BBBY stock has great upside potential over the next several years. The problem is that the likelihood of a turnaround is low. Much like RadioShack, Sears, K-Mart, and J.C. Penney (NYSE:JCP), Bed Bath & Beyond falls into the category of retailers that consumers simply don’t need anymore.
I don’t see what management can do to change that. Competition is getting bigger and better. That competition has more resources. They can win the price battle. They can win the convenience battle. Ultimately, they can do everything Bed Bath & Beyond does. They can just do it better.
As such, the most likely path forward for BBBY stock is lower for longer.
As of this writing, Luke Lango was long AMZN and TGT.
More From InvestorPlace
- 2 Toxic Pot Stocks You Should Avoid
- The 7 Best Bond Funds to Buy for a Shift in Interest Rates
- 10 Tech Stocks With Key Products That Face an Uncertain Future
- 7 SaaS Stocks to Buy for Long-Term Gains
The post Dump BBBY Stock Because There’s No Turnaround Coming appeared first on InvestorPlace.