Bed, Bath & Beyond Adolescence - TheStreet

Bed, Bath & Beyond Adolescence

Its 10-year track record of 25% annual growth could be over.
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Has

Bed Bath & Beyond's

(BBBY) - Get Report

decade-long run of 25% annual earnings growth finally caught up with it?

That's what investors are trying to figure out -- and they're increasingly answering yes. Shares in the household goods retailer have sold off in recent weeks amid concerns the company has run out of places where it makes sense to launch new stores.

Every retail company hits an "inflection point," where its growth starts to slow and investors start focusing more on how its existing stores are performing than on how many stores it's opening, said Gary Farber, a partner with hedge fund Nightingale & Farber. Bed Bath & Beyond is starting to hit that point, he said.

"It's the law of large numbers. The growth is going to slow," said Farber. "You can make a valuation story, but that's not a great reason not to own it unless there's something else there."

This kind of concern is something new for Bed Bath & Beyond, which has been something of an investors' darling. The company has been one of the few fast-growing retailers, posting per-share earnings gains of greater than 25% in each of the past 10 years. The stock, meanwhile, is up more than 200% over the last five years.

But recent events have led to questions from investors and analysts. Although the company's annual earnings growth jumped from 25% in fiscal 2002 to 35% in fiscal 2003, its growth in square footage and store openings slowed. The company ended its fiscal year in March operating 490 stores comprising 17.2 million square feet of space, up 23.7% and 17.2%, respectively, from the previous year.

Those were healthy numbers, to be sure. But the company's square footage grew at its slowest pace in 11 years. And Bed Bath & Beyond's store count increased at the slowest percentage rate since 1994, when the company ended its fiscal year with just 45 stores.

The company argues that it can continue to grow, if at a slower pace. Management believes that Bed Bath & Beyond could have up to 950 stores in the long term.

But the company's first-quarter earnings

report last month and its subsequent

purchase of Christmas Tree Shops fanned the critical fires.

Although the company's earnings topped Wall Street's consensus, its revenue numbers fell short of the Street's rosier projections. The company opened just eight stores in the quarter, far off its previous pace, and its square footage was up just 15.5% over the same period last year. The company warned that store space and revenue growth would slow down from previous levels.

Meanwhile, some saw the acquisition of the 23-store Christmas Tree Shops as evidence the company knows its days of organic growth are nearing an end.

In a note issued earlier this month initiating coverage on the company, Collin McGranahan of Bernstein Research summed up the bear view. Bed Bath & Beyond is a maturing company whose days of growth are ending, McGranahan said. Square footage is already declining, he noted, and the only way for the company to continue to add stores is by expanding into smaller, less profitable markets or by cannibalizing the sales of existing stores, he said.

"We think

the significant deceleration in Bed Bath store square-footage growth is lasting and will lead to

an increased vulnerability to home furnishings cyclicality, moderation in comp-store sales trends and decelerating earnings growth," McGranahan said in his note. "Current valuation embeds an optimistic view of the medium- to longer-term growth potential. However, the stock remains relatively expensive today, and we think

price-to-earnings multiple compression is likely from these levels, as investors discount decelerating earnings growth." (Bernstein doesn't do investment banking.)

At the time of the Christmas Tree acquisition, Bed Bath & Beyond was trading at more than 30 times the company's projected current-year earnings, a pricey multiple for an established retailer. That was rich enough for some investors, and the stock is down 11.4% since it reported earnings last month. In contrast, the S&P Retail Index is up 2.3% in the same time period as companies such as

Wal-Mart

(WMT) - Get Report

,

Target

(TGT) - Get Report

and

Lowe's

(LOW) - Get Report

have held steady or gained.

Nevertheless, several sell-side analysts reiterated positive ratings after the earnings announcement. And some praised the company's Christmas Tree acquisition, saying that it would provide continued, complementary growth.

"

Bed Bath & Beyond's back is not up against the wall. It is not acquiring out of a need to grow," wrote Banc of America Securities analyst Aram Rubinson in a report last month. "Rather, the acquisitions it is making are more integral to the core than most retail acquisitions. At the same time, Christmas Tree Shops may be a crucial sourcing and merchandising partner." (Banc of America Securities has an investment banking relationship with Bed, Bath & Beyond.)

One hedge fund analyst concurs, saying the recent selloff in Bed Bath & Beyond shares has been overdone.

The analyst, whose fund is long the stock, praises the company's management team, saying they've done a good job at managing Wall Street's expectations. As they've been in the past, Bed Bath & Beyond's managers are likely being conservative about square footage and earnings expectations to give themselves room to surpass expectations, said the analyst, who asked not to be named.

The company is continuing to open stores and is continuing to grow, the analyst said. Bed Bath & Beyond's same-store sales, which compare results at like outlets open for more than one year, grew by an impressive 4.4% in the first quarter, while other companies struggled, the analyst noted. And the acquisition is a better use of cash than buying back shares or paying a dividend, the analyst said.

"I think it's a real class story," the analyst said.

Maybe so, but the piling on of stores isn't necessarily a growth panacea. Analysts point to another one-time highflier that tried the same strategy and lost:

Toys R Us

(TOY)

, which kept heaping big-box stores into smaller and smaller cities with decreasing returns. It now trades around $12 and at an earnings multiple of about 11.

Says another retail analyst: "Toys R Us proved that you can grow yourself into the ground."