Bed Bath & Beyond Inc. (BBBY) Is Still Attractive Despite Run-Up

Bed Bath & Beyond Inc. (NASDAQ:BBBY) is up nearly 8.5% since the start of the year, but the company’s long-term operating history and recent initiatives suggest that the stock has a lot more appreciation potential in the year ahead.

Efficient Operator

Bed Bath & Beyond sports the highest operating margin in its peer group despite selling its products at a similar price point.

The company is able to achieve this feat due to its superior sales productivity; it has more sales per square foot than Williams-Sonoma, Inc. (NYSE:WSM) and Pier 1 Imports, Inc. (NYSE:PIR). The company’s liberal return policy deserves a lot of the credit for high sales per square foot; customers who come in looking for just one item often leave with multiple items because returns are so generous. This also creates loyal customers.

In addition to high sales productivity, Bed Bath & Beyond Inc. (NASDAQ:BBBY) has also shown a knack for efficient merchandising. The company’s defensive products, such as linens, towels, and cookware, offer protection from downturns in cyclical products like those closely related to the housing market.

Bed Bath & Beyond is finally investing in its website to better compete with Williams-Sonoma’s vast e-commerce presence. The company has additional growth opportunities in Canada and Mexico that will be aided by its e-commerce build-out.

Competition

Williams-Sonoma represents Bed Bath & Beyond Inc. (NASDAQ:BBBY)’s challenge to long-term prosperity. Williams-Sonoma has a large presence on the internet — nearly 40% of its sales are made online. Its internet segment is the fastest-growing part of the business. It will be difficult for Bed Bath & Beyond to ever catch up with Williams-Sonoma’s online presence.

Pier 1 poses a smaller niche threat to Bed Bath & Beyond. Pier 1 is pursuing a much narrower merchandising strategy that does not scale as well as Bed Bath & Beyond’s. In addition, Pier 1 does not have the same product diversification that allowed Bed Bath & Beyond and, to some extent, Williams-Sonoma to weather the recession relatively unharmed. As a result, Pier 1 does not pose a serious existential threat to Bed Bath & Beyond in its current form.

Valuation

Since 2002, Bed Bath & Beyond Inc. (NASDAQ:BBBY) has averaged a 46% pre-tax return on tangible invested assets (defined as tangible assets minus cash). The company’s return has nearly always been above 51% except during 2007-2009.

However, for purposes of valuation, I will assume a pre-tax return on tangible invested assets of 40% going forward. This is to account for hiccups in the e-commerce renovation as well as lower-than-expected returns on its recent acquisitions.