Problems at Textile Mills Loom Large for Bed Bath & Beyond - TheStreet

Home-furnishings retailer

Bed Bath & Beyond

(BBBY) - Get Report

has muscled its way to the top of its sector by offering consumers vast selections at reasonable prices -- and unlike what's happened at some other retailers, those customers have kept coming back amid the faltering economy. Along the way, investors have made bundles of cash investing in the company's stock.

But the party could be over, at least for investors.

Despite recently announcing a stellar fiscal first quarter that saw earnings rise a healthy 25%, a few Wall Street analysts are starting to raise red flags. The company's stock, by most valuation methods, is expensive, they say. And, perhaps more importantly, many of the company's largest suppliers -- particularly textile mills -- are facing hard economic times. The worry: that a serious disruption in Bed Bath & Beyond's supply chain lurks in the not-so-distant future.

A recent report published by

UBS Warburg

analyst Aram Rubinson discussed the problems at the company's suppliers. One company,

Thomaston Mills

, recently announced it may shutter its doors, while others, such as

Pillowtex

and

Glenoit

, are trying to get out of Chapter 11 bankruptcy protection, the report notes. And

WestPoint Stevens

(WXS)

, the industry leader with about $1.9 billion in sales, has seen its share price plunge in recent months from about $10 to around a buck amid falling sales and liquidity concerns.

The Effect

"The question we have is what effect, if any, will be felt in the retail channel," Rubinson writes. "So far, there have been no repercussions, but we are loath to turn a blind eye. After all, it is the largest suppliers that are faltering, not the smallest. And it is becoming increasingly likely that some of the business will get dislocated." (Despite these worries, Rubinson has a buy rating on the stock. His firm hasn't done underwriting for the company.)

Rubinson contends Bed Bath & Beyond, based in Union, N.J., could be hurt worse than other retailers by the woes at the nation's mills because an estimated 55% of its sales is from home textiles, such as bedding and curtains. "The issue we are keen to understand is how retailers will balance sourcing if and when a break in the supply chain were to arise, since switching suppliers takes both time and planning," he says.

The company declines to address the issue.

"We don't respond to anything that is an analyst assessment of a situation," says Kenneth Frankel, the company's director of financial planning. "We understand the marketplace and react accordingly."

If the company's performance over the past few years is any indication, investors can assume management is on top of the situation. Operationally, the company is among the healthiest of retailers, analysts agree. Its earnings and comparable-store sales -- which measure activity in shops open at least a year and are a key barometer for gauging a retailer's performance -- all are rising at a healthy clip, despite economic jitters. The company has tons of cash flow and plenty of room for expansion -- by its own estimate it owns only about 4% of the home-furnishings market.

Impressive Run

But aside from supplier worries, investors must be wondering how much more in returns can be wrung from Bed Bath & Beyond stock in the near future. The stock has had an impressive run: Since the beginning of the year, the shares have risen more than 40% and recently traded at $30.69, outpacing both the broader market and other retailers; the

S&P 500

is down close to 8% on the year, while the

S&P Retail Index

is up just over 2%.

Well Beyond
Bed Bath & Beyond's stock has outpaced the broader market so far this year

Investors need to ask themselves how much they are willing to pay to stake a claim to those earnings, which are expected to grow at a robust 25% annual clip over the next five years, according to

Thomson Financial/First Call

. At recent levels, the price appears steep.

"If valuation was not a part of equity analysis, we would definitely have our strongest positive rating on the shares, given our notion that Bed Bath & Beyond will continue to gain market share faster than any other home-furnishings retailer further solidifying its dominant position," writes

A.G. Edwards

analyst Brian Postol in a recent report. He has a maintain rating on the stock -- which in Wall Street parlance means don't buy the shares -- but would consider advising clients to buy the stock if it fell to the mid-$20s range. (His firm hasn't had an underwriting relationship with the company.)

Lofty Bed

At recent prices, the company trades at a lofty 43 times this fiscal year's Thomson Financial/First Call consensus earnings estimate, a higher premium than that given to such retail stalwarts as

Wal-Mart

(WMT) - Get Report

or

Home Depot

(HD) - Get Report

, though they have lower projected annual earnings growth rates over the next five years -- 15% for Wal-Mart and 20% for Home Depot, compared with 25% for Bed Bath & Beyond, according to Thomson Financial/First Call.

"Outside of valuation concerns, we believe this is a solid equity over the long term," Postol says.

But those valuation concerns may be tough for some investors to get over.