3 Issues Morgan Stanley Sees With Bed Bath & Beyond's Earnings

Bed Bath & Beyond Inc. BBBY reported its 1Q results, with the EPS missing expectations, driven by worse comps.

Morgan Stanley’s Simeon Gutman maintains an Underweight rating on the company, with a price target of $40.

Weak 1Q

Gutman mentioned this was the company’s weakest gross profit dollar performance in three years, driven by comps and a dilutive shift to e-commerce.

The analyst pointed that that Bed Bath & Beyond’s 1Q results highlighted three investment issues.

3 Issues

First, Gutman believes the channel shift from store to online continues to pressure margins, with gross margins having declined 75 bps and EBIT margin contracting 220 bps to become the lowest Q1 EBIT margin since 2008.

“To be fair, Q1 is the smallest seasonal quarter, 2016 was slated to be an investment year and the removal of quarterly guidance may have led to a wider margin/EPS miss vs. consensus relative to the company’s internal plans,” the analyst explained.

Related Link: Still Unclear When Bed Bath & Beyond's Initiatives Will Bear Fruit

Although management indicated that the Q1 results were “directionally in-line” with their plans, the channel shift is likely to impact both EBIT margin and ROIC.

“Second, this channel shift was exacerbated by negative overall comps and negative low single digit store-only comps,” Gutman said.

The analyst believes that while the consensus expectations assume comp growth, they ignore the market share growth among competitors.

Although several discretionary product retailers seemed to have struggled in 1Q and due to the timing of Memorial Day, the analyst believes that the market share shift was responsible for Bed Bath & Beyond’s comp weakness.

“Third, we still do not see a profit inflection. In-store and e-commerce investments are expected to continue and there is heightened risk of margin pressure in light of weaker comps,” Gutman concluded.