Retailer Bed Bath & Beyond (Nasdaq:BBBY) managed to beat expectations on the earnings and sales fronts in its first quarter, but Bed Bath bulls shouldn't break out the champagne just yet.
The good news is the company earned $76.8 million (30 cents per share) on $1.65 billion in sales in its first quarter ended May 31. The results were much better than the 27 cents per share and $1.62 billion in sales that the analyst community had been expecting. The bad news is that beyond these healthy numbers the company looks sickly underneath. Margins and inventory are the real story for the quarter, and unfortunately for investors, this story doesn't have a happy ending.
The Incredible Shrinking Margins
In the most recent quarter Bed Bath & Beyond's gross margin came in at 39.8%. This is nearly 200-basis points lower than the 41.6% gross margin it put up in the comparable period in the prior year. That a big drop, and it suggests to me that the company is likely marking down and couponing its merchandise.
I realize the company is operating in a tough space and that some margin pressure is to be expected, but this was a steep decline, and it makes me wonder how much more erosion we might see before things start to level off.
Next, let's compare the margins at Bed Bath & Beyond to those of Target (NYSE:TGT) and Wal-Mart (NYSE:WMT), two big name players that carry a great deal of similar merchandise.
- Target - In its first quarter ended May, Target posted a gross margin of 33.1% which is up from the 32.9% it turned in during the comparable period the year before.
- Wal-Mart - In its first quarter, Wal-Mart's gross margin came in at 24.6%, which is up from the 24.4% it turned in during the comparable period last year.
Neither of these were a huge jump, but they were increases nonetheless. These results show that it is possible to do well even during a mini-recession. (Take a deeper look at a company's profitability with the help of profit-margin ratios, in our related article The Bottom Line On Margins.)
Inventories Jump
Merchandise inventory rose to $1.7 billion from $1.6 billion in the comparable period last year in the most recent quarter. That's 10.8%. It's possible that this is just a blip on the radar screen and that over the next quarter or two it might level itself out. However, it does seem a bit steep given that:
1) Sales in the quarter were up only 6.1%.
2) Analysts are expecting the company to generate about $1.86 billion in sales in the August quarter. Note: That would be about a 5.2% jump over sales it generated in the comparable quarter in 2007.
You would hope that inventory levels would not outpace sales growth. The fact that the inventory rose faster than sales suggests that Bed Bath & Beyond is having a tough time selling some of its wares, and that it might have to heavily discount or coupon in order to flush out the excess. This would mean even more margin pressure. (We go over some methods of calculating inventory, in Inventory Valuation For Investors: FIFO And LIFO.)
Bottom Line
Bed Bath & Beyond's first quarter numbers came in north of expectations. Usually this would be great news, but unfortunately there was more to the story. Margins were pinched during the quarter, and with inventory levels rising, we could see even more margin pressure in the future. I think the stock should probably be avoided for now.
