No Seriously, Show Me The Money!

By Chad Henage - September 21, 2012 | Tickers: BBBY, M, TGT, WMT | 0 Comments

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The saying goes that a fool and his money are soon parted, but there is one company that looks foolish (small f) for not giving investors what they deserve. Bed Bath & Beyond (NASDAQ: BBBY) recently reported earnings that didn't live up to expectations. While I think the market overreacted, if the company would institute a dividend, I believe the shares would be much more stable than they are today. Let's take a look at what happened in the current earnings report, and examine why I believe a dividend is long overdue.

Bed Bath & Beyond's reported earnings were actually not that bad. However, in this market a company that misses earnings estimates is punished, and the stock certainly was by dropping over 9% today. With sales up 12.1%, and comparable sales up 3.5%, you would expect the company's earnings grew a decent amount. However, EPS only increased 5.4% which was a big reason the shares were down as much as they were. There is one primary reason that EPS didn't keep up with sales growth, but more on that later. If investors have anything to be frustrated about, it's the fact that the company refuses to pay a dividend even though their financials clearly indicate they could.

When you look at Bed Bath & Beyond's competition, three of their major competitors all pay a dividend with a yield over 2%. In the home furnishings business, a few major players are Macy's (NYSE: M), Target (NYSE: TGT), and Wal-Mart (NYSE: WMT). While all three of these companies have primary businesses beyond just home furnishings, they all represent serious competitive threats and should not be underestimated. To get an idea of the strength in pricing at Bed Bath & Beyond, take a look at the operating margin at each of these companies.

(based on each company's most recent quarter) 

Obviously Bed Bath & Beyond is turning more of their sales into operating profit than their three major competitors. However, the company is primarily using this additional cash generation to fund share repurchases rather than a dividend. I've examined the numbers in the past, and the company's current quarter just reinforces the point. This company can afford a dividend even if they continue retiring shares.

In the last year, their diluted share count has dropped nearly 7%, and without acquisitions their cash and investments would have stayed almost the same. In the current quarter, Bed Bath & beyond generated over $300 million in free cash flow, which would indicate an annual run rate of over $1 billion. In my prior assumptions, I expected free cash flow at $900 million. Even using a conservative 30% payout ratio, the dividend would equal roughly $1 per share. After the drop in the share price today, this $1 annualized dividend would be the equivalent to a 1.61% yield. Keep in mind, this would still leave 70% of the company's free cash flow for share repurchases. Even with the most recent miss, in the last four quarters the company has beaten earnings by a total of $.21 per-share. Assuming a dividend were instated, share repurchases would have to be somewhat curtailed. However, I think it's reasonable to expect the company would still be ahead of estimates over the last multiple reporting periods. The need for a dividend from Bed Bath & Beyond is clear when you look at the combined growth rate and yield of their competition.

Given four different stocks to choose from, if one company offers a roughly 11% expected return, and two others offer a 14%+ return, which would you choose? This is essentially the question being asked of investors when they look at Bed Bath & Beyond versus Macy's and Target. Both Macy's and Target offer investors not only 12%+ earnings growth, but a yield of more than 2% as well. With Bed Bath & Beyond not paying a dividend, at best investors can expect earnings growth of just less than 11%. By this measure, even Wal-Mart's combined earnings and yield offer an attractive alternative. The world's largest retailer offers a yield north of 2% and expected earnings growth of better than 8%.

The bottom line is, Bed Bath & Beyond consistently generates positive free cash flow far above what they are using for share repurchases. If this continues and the company declines to pay a dividend, investors would be better served choosing a different retailer for their portfolio.

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