GME - Bed Bath & Beyond Is Burning Cash And Has No Growth Catalysts

2023-03-09 19:49:31 ET

Summary

• Bed Bath & Beyond is in bad shape financially but is raising money through warrants out of necessity and it also closes several stores.
• I expect Bed Bath & Beyond to file Chapter 11 soon, which will cause the shares to fall sharply.
• However, it is still possible that the stock price will spike sharply in the short term due to the high short interest.
• BBBY will first have to replenish its cash position, and increase its revenue, profit and free cash flow.
• I don't see that happening within the next year or so because of the high inflationary environment and the poor economic outlook.

Introduction

Bed Bath & Beyond ( BBBY ) is a stock that speculators know from the short squeeze in early 2021. The share price shot up “to the moon”. Currently, the share price has fallen sharply because the company is in financial trouble.

Short sellers see this as an opportunity and currently a significant portion of the outstanding shares are short. Is this justified or are the short sellers wrong? In the short term, I see bright spots for the company, but it is too early to judge whether the shares are worth buying. For now, I see no growth catalysts and therefore I give BBBY stock a sell rating.

Short Squeeze Potential

Bed Bath & Beyond experienced a strong gamma squeeze in early 2021. Not only did Bed Bath & Beyond experience a strong gamma squeeze, but Gamestop ( GME ) shares also rose significantly.

A gamma squeeze occurs when a group of buyers buy the stock en masse and bid the price up in conjunction with the purchase of call options. The stock buyers then stop offering their shares to short sellers. Something Martin Shkreli did with pharmaceutical stocks. Short sellers are seen by some as evil speculators because they speculate on a decline in the company's value.

The rise of a stock then causes even more short sellers to panic and close their short position (they buy shares). And meanwhile, many speculators buy call options that give them the right to buy 100 shares before a certain date at only a small premium. Banks cover these option positions, and because of the huge demand for call options and the huge demand for shares, the share prices will experience a huge rise.

We recognize stocks that have potential for a gamma squeeze by the high short interest compared to their outstanding shares.

We take a quick look at the charts of short interest and shares outstanding.

We see that the short interest in 2021 was about 75 million shares, and the outstanding shares then were about 125 million. That means that as many as 60% of all outstanding shares had shorted, a huge number. Then short sellers bought up the shares en masse, causing the short interest to drop to 20 million, and the share price to rise sharply.

Recently, short interest rose sharply again. Today the short interest is 65 million, and there are 117 million shares outstanding. This means that 56% of the shares are short. Again, this is a huge number. Speculators are skeptical that the company (and the stock price) will improve.

Bed Bath & Beyond has a high potential for a short squeeze because of the large number of shares sold by short sellers. An improvement in cash flow figures, or the company's financials are catalysts to push the stock price up. If the company comes out with strong financial figures, the stock price could skyrocket.

There Is Improvement, But The Company Is Still Struggling

Recent fiscal results for the third quarter of 2022 show poor results; net sales were down 33% (due to a comparable sales decline of 32%). The company greatly reduced SG&A expenses, but they are still high: $584 million this year versus $698 million last year. The quarter ended with a $101 million loss due to asset revaluation. Cash flow from operating activities was negative at $550 million for the quarter. The numbers do not look rosy and their main task right now is paying down debt, the company is doing this by closing many stores.

We gain insight into the historical figures by taking a closer look at the cash flow statements. Bed Bath & Beyond paid a dividend but reduced the dividend in 2021 and currently the company pays no dividend. We also see that the company repurchased shares for $380 million in 2021 and $589 million in 2022. The buyback yield was huge at 43% in 2022.

Buying back shares in the open market creates more demand, which means there is a higher chance the stock price will rise; this is disastrous for short sellers. Bed Bath & Beyond has done well to buy back shares, leaving short sellers with a loss in 2021.

However, the share buyback program is only temporary and not sustainable for the long term because its free cash flow was negative at -$336 million for 2022. Bed Bath & Beyond has used their cash reserves and will have to ensure that the company becomes profitable soon.

Bed Bath & Beyond's cash reserves are $154 million, according to recent quarterly figures, and with free cash flow of -$336 million in 2022, that means it will have to raise money from banks or investors by issuing stock or bonds. Recently the company announced that they have received a total of $360 million in gross proceeds through the exercise of preferred stock warrants, the company can count on additional $800 million. They are using this to pay off outstanding revolving loans and debt and replenish their cash reserves. This has improved the outlook somewhat.

Still, I don't think this will be enough. Total debts are about $2B, sales are down sharply, and the company is burning cash. I expect that after paying off the debts, the company will still have $1B of net debt on its balance sheet.

With projected sales of only $4.8B in 2024, net debt is still way too high. In a good year, its free cash flow yield (FCF/Revenue) was about 5%, so if the company returns to profitability, the free cash flow would be only $240 million in 2024. The net-debt to free cash flow ratio is then 4.2, which I think is a very high number for a retailer with a low profit margin and high overhead.

To pay off more debt, they could issue common stock but with a market capitalization of only $151 million, they won't have much use for that. I also don't think that banks will be willing to lend the company money because they wasted their cash on share buybacks in 2021.

Bed Bath & Beyond Is Valued Expensively

The valuation of shares is of little importance in this case because the company is in financial difficulty. Nevertheless, I want to show that the company is expensively valued relative to its revenue. Enterprise value includes cash and debt in the valuation, and because of the huge increase in debt and decrease in revenue, we see that the company is not listed at an attractive valuation at all, despite the fact that the stock price has fallen sharply.

Conclusion

Bed Bath & Beyond is in bad shape financially but is raising money through their warrants out of necessity and it also closes several stores. This allows it to pay off (part of) its debts. Recent quarterly figures show a bad picture with sharply declining sales and negative cash from operations. Their high SG&A costs have barely bottomed out, so I expect them to continue to burn cash in 2023. I expect Bed Bath & Beyond to file Chapter 11 soon, which will cause the shares to fall sharply. However, it is still possible that the stock price will spike sharply in the short term, such as it did in mid-January and early February due to the high short interest. For the long term, Bed Bath & Beyond is certainly not buy-worthy (yet). For that, the company will first have to replenish its cash position, and increase its revenue, profit and free cash flow. I don't see that happening within the next year or so because of the high inflationary environment and the poor economic outlook.

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