The Stuff of Nightmares

 | Jun 25, 2013 | 10:30 AM EDT
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Bed Bath & Beyond (BBBY) is set to report earnings on Wednesday after the close, and judging from the run up in the stock, it seems investors are anticipating a solid quarter. However, I would be surprised if Bed and Bath met expectations for the quarter. In the past, the company has had difficultly during the May and August quarters and I don't think it will be any different this time.

The first and second quarters of Bed and Bath's fiscal year always seem to give investors night sweats. If you look back, the company has missed estimates for the first quarters in 2010, 2011 and 2013, and I think that will happen when it reports on Wednesday as well.

Analysts always seem to overestimate the first-quarter's results. For example, last year, the Street thought the company would earn $2.56 billion on a 40.25% gross margin. But that wasn't the case. First quarter fiscal 2013 came in at just $2.218 billion with a 39.99% gross margin. After that miss, it was obvious that analyst second-quarter estimates were too high. The Street was at $2.7 billion and the company could only get to $2.59 billion. Disaster ensued as the stock slid sharply.

The stock has recently run higher because investors believe the housing market is in the early stages of recovery. In addition, the Cost Plus/World Market Stores acquisition should be accretive to earnings and the company is about to launch a revamped e-commerce platform for Buy Buy Baby. The company plans to launch a new Bed & Bath website by the end of the second quarter as well. Bed and Bath recently acquired Cost Plus/World Market Stores, which sells home furnishings, décor and gifts. Similar to the company's acquisition of Christmas Tree Shops in 2003, I think World Market stores will help to lower BBBY's gross margin.

And that's the problem. Bed, Bath and Beyond may be adding additional revenue by acquiring these chains, but the deals are weighing down BBBY's overall gross margin. For example, Christmas Tree Shops only has a 25% gross margin vs. BBBY's 40% margin. Likewise, World Market seems to be another addition with a lower margin.

For the first quarter, analysts are estimating revenue of $2.6 billion, which would be a 17.3% year-over-year increase in revenue and $0.93 in earnings. Most of that 17% increase will be the Cost Plus acquisition. In 2013, the first quarter only grew 5%. While the top line is being boosted by deal making, the gross margin line is under pressure. I think margins will come in under expectations of 39.02%. If you recall, it wasn't long ago the company ended fiscal 2012 with a 41.38% gross margin.

Even if revenue comes in as expected, I think margins will continue on their downward slope and pull the stock lower as investors are once again disappointed by the company's results. Bed, Bath and Beyond is sure to keep investors up at night.

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