Bed Bath & Beyond: Be Careful of the Free Cash Flow Defense

Bed Bath and Beyond reported 1Q earnings that were drastically below what were already low expectations heading into the quarter.  The company reported EPS of $0.53, which was well-below consensus of $0.66, and the stock declined 12% on Friday.

There have been some contrarians that have come out in defense of the company, arguing that Bed Bath & Beyond generates significant free cash flow and returns much of that in the form of share buybacks and dividends.

But here's why that argument is misguided. This sort of defense works for a company like Staples, where profitability is stable, and net income is flat. This is not the case for Bed Bath & Beyond, which has deteriorating fundamentals across the board. Free cash flow will eventually follow, meaning that share buybacks and repurchases are not sustainable.

To show this, I'll first walk through the deterioration in fundamentals. I'll then connect this to free cash flow and show how that hurts the free cash flow outlook going forward. Finally I'll address what I see as the bull case is for the stock.

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Word on Wall Street: Can Lulu Return to its Former Glory?

Lululemon was at one point on top of the world. The company's yoga pants became a huge hit - not just with hardcore yoga practitioners, but also with a more casual audience. The stock grew from ~$4 in 2009 to its peak of $82 in June 2013. However, that year, the company ran into a slew of quality-control issues (see-through pants, pilling), increased competition (Nike, Under Armour, and a bunch of copycats), and supply chain problems. And more recently, just as the company was beginning to return to a solid state of revenue growth and margin expansion, the company again ran into execution-related issues in 1Q17. As a result, the company now sits 34% off of its 2013 peak, which it had recently approached in August of last year.

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Word on Wall Street: A Closer Look at CMG's 1Q Results

First and foremost, Chipotle's 1Q was better-than-expected on the two main metrics that matter - comps and restaurant-level margins. With national advertising just now turned on and digital performing strongly, the outlook now looks better than it did before the earnings report, and the stock is up ~3% on the day after.

With that said, the report was not enough to persuade bears to flip sides. Most of the discussion was focused on comps, which was distorted by several factors. And with some deeper digging, one could find enough wrinkles in the quarter to remain bearish on Chipotle's outlook. And that's why the stock has only had a modest gain despite such a strong quarter.  You need thesis-changing operational results to drive 10%+ moves, and this wasn't it. 

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Word on Wall Street: Amazon International and Margin Upside in Focus

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Word on Wall Street: Costco Comps Expected to Accelerate in 2H17, but Will Competition Catch Up?

Costco has largely traded sideways over the last year after a 92% run between April 2012 and December 2015. The stock's upward trajectory slowed as the company's core comps began to slow amid increasing food deflation, the removal of tobacco products, and an increasingly competitive retail environment. Today, the key question revolves around where same store sales will move from here - will they return to COST's historical mid-single-digit growth, or will they continue to remain pressured as competitors increasingly encroach on their territory?

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Word on Wall Street: FactSet Bear Case Gaining Steam as Pressure on Buy Side Mounts

FactSet is a data provider to financial service firms. If you work at a bank or on the buy-side, you're probably familiar with their products. FactSet's core desktop platform is used widely by analysts to pull data for research purposes or to monitor a portfolio. Sentiment among the Wall Street investors has declined significantly; among the major brokers, there's 1 buy, 10 holds, and 5 sells. The stock has held in relatively well, but has had significant drops around earnings as the company has missed revenue expectations. While the company fundamentals and its stock has performed well on an absolute basis, there is growing evidence supporting the bear-case around the stock.

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Word On Wall Street: Tesla Model 3 Trade On Track, but Is S/X Demand Slowing?

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However, many investors remain skeptical of Tesla. Looking beyond the Model 3 trade, many investors are debating what is happening to underlying demand for Tesla's older models.

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Word on Wall Street: Adobe Benefiting from Shift to Cloud, but Is Risk/Reward Favorable?

Adobe has shot through the roof, gaining 279% over the last 5 years. The stock has benefited primarily from the ongoing shift of marketing/media to the internet, as well as Adobe's product shift towards the cloud. As people's eyeballs move towards our screens, advertising and content creation is increasingly following it. In turn, people are increasingly demanding more tools to create, distribute, and analyze/optimize content. Adobe's suite of products are perfectly positioned to address these issues.

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Word on Wall Street: Investors Focused on Mylan's Advair Generic, Not EpiPens

Many of us know of Mylan due to the EpiPen controversy, which became the poster child for healthcare and its out-of-control pricing in America. In late August of 2016, the media began reporting on the significant price increases on the EpiPen, which had increased from $100 in 2007 to $609 in mid-2016. Up to that point, the drug had become the primary component of Mylan's earnings, with a significant portion of profitability coming from the business (with some estimates placing it at 40% of its operating profit).

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The Looming Technology That Could Crash the Auto Part Party

The auto part retailers have long been the darlings of the retail industry with consistent earnings growth, the highest margins in the sector, and protection from online players. And as a result, the stocks have been rewarded with a high valuation and market outperformance. However, there's a looming technology that could disrupt the industry that I don't think is being accounted for by investors. 

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Word on Wall Street: Pharma Segment Key to JNJ Performance in 2017

Johnson and Johnson stumbled a bit in the second half of 2016. The stock declined slightly 11% from July to late January as investors began to focus in on the Pharmaceutical segment and its growth trajectory. The segment, which represents 47% of sales, has driven much of JNJ's top-line growth over the last four years with over 10% organic growth each year. However, growth in this segment began to slow noticeably to 2% in 4Q16. Additionally, management gave segment guidance that implied growth of just 2-3% in 2017. In turn, street estimates were lowered. 

What has been driving the growth moderation and the investor concerns?

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Word on Wall Street: Will Customers Come Back to Chipotle?

A lot has happened to Chipotle since I last wrote on the stock back in October of last year. As is well known, Chipotle faced a number of health-related issues that forced the closure of numerous stores. Many restaurants have faced similar outbreaks in the past, but those restaurants did not have consecutive strings of outbreaks, nor did it happen during a time when social media allowed news to spread quickly. As a result, sales dropped off a cliff and the stock has declined by 45% since the initial reports. For those who hold very strong beliefs on the future of a company, the outbreaks serve as a stark reminder that the future for any company is never certain.

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Word on Wall Street: Restoration Hardware One of the Few Exciting Transformations in Retail

Restoration Hardware is currently undergoing a massive real estate transformation. The company is in the early innings of a shift from small, 7,000 foot stores to large, 35,000 - 60,000 square foot "full line design galleries" (FLDGs). The company eventually hopes to triple or quadruple its square footage over time as it adds 70 of these massive stores throughout the country.

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Word on Wall Street: Detailing FB's Longer-Term Revenue Drivers and Bear Case

Facebook is a widely loved stock among both the buy-side and sell-side analysts. One of the reasons for the optimism is Facebook's near-term revenue growth drivers in video and Instagram, as I detailed yesterday. Beyond these factors, the company also has a number longer-term sources that hold a significant amount of potential. Specifically, Facebook's messaging apps, Facebook Messenger and WhatsApp, have an even greater number of users than Instagram and could unlock further growth beyond 2016. Additionally, Facebook's virtual reality company, Oculus, holds potential beyond PC and mobile as the next computing  platform.

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Word on Wall Street: Detailing FB's Near-Term Revenue Drivers

The FB bull thesis is made up of a number of revenue drivers that could drive advertising revenue and EPS upside. In the near-term, investors see a number of positives that could benefit sales, including easing comparisons and FX headwinds. Beyond these superficial tailwinds, investors are most  bullish on the opportunities from video and Instagram, which are not fully baked into consensus estimates for next year.

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