Bed Bath & Beyond shares jump on strong results

Bed Bath & Beyond is expected to get a long-term boost from the disappearance of Linens 'n Things, a primary competitor that filed for bankruptcy in 2008. From October 2008 to February 2009, Linens 'n Things was liquidating its store and online inventory, which pressured sales and margins at Bed Bath & Beyond. This quarter will be Bed Bath & Beyond's first full quarter following the completion of the wind-down of Linens 'n Things.

With trailing twelve month EPS of $1.69, the stock trades for about 18x earnings. But with about $3.50/share in cash and auction-rate securities, the real earnings multiple here is closer to 15x -- as I said yesterday about Walgreen's, that's not a screaming bargain. Typically, I'd expect a stock priced like WAG or BBBY to give a long-term return in the mid-to-high single digits. But I don't see Walgreen's and Bed Bath & Beyond as being equal, because the competitive landscape has changed so much for the latter.

Unlike Linens 'n Things, which had a large debt load after being taken private, Bed Bath & Beyond has no debt. While extra cash on the balance sheet is great in that it allows flexibility, I'd argue that Bed Bath & Beyond is actually underlevered and should start to deploy some of that cash into attractive investment opportunities (i.e. new stores) or return it to shareholders through a special dividend. There will be less competition in the space for some time, leaving significant incremental profits to be made from former Linens customers (I've seen analyst estimates ranging from 21-50 cents per share annually), as well as reduced gross margin pressure thanks to less promotional activity.

Management has done a good job handling the downturn so far. But at some point, the survivors need to look around and realize that the competitive landscape -- which had been crowded in good times -- has finally opened up. Likewise, investors need to be on the lookout for best-of-breed operators who have newfound pricing power, as it can create a string of earnings beats that push a stock higher. While I'd normally have only moderate enthusiasm for a retail stock, at Bed Bath & Beyond's valuation, future earnings will likely be substantially higher.

James Cullen also edits and writes at CollegeAnalysts.com. He has no position in the stocks mentioned above.