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Stock Strategist

Spending Shift Bites Bed Bath & Beyond

But we still like the business model and think the stock's undervalued.

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No-moat  Bed Bath & Beyond's (BBBY) shares have fallen in tandem with those of many softlines retailers as consumers have shifted their spending in recent periods to more durable categories. However, we think the firm still has a defensible business model as a best-in-class merchandiser in the home, baby, and beauty goods markets. While we don't expect the cadence of couponing to slow over the near term, we think the improving omnichannel presence, disciplined real estate expansion process, and still-robust international opportunities will help offset the company's inability to price at a premium, ultimately leading to modestly higher operating margins over the next decade (13.5%). Incorporating low-single-digit top-line growth (supported by Morningstar's mid-single-digit outlook for spending in the repair and remodel market through the end of the decade) with moderate selling, general, and administrative expense leverage over time underlies our $75 fair value estimate. We believe the shares are out of favor because of consumers' temporary shift away from lower-price discretionary items, and they are trading at an attractive discount to our valuation.

Additionally, we see Bed Bath & Beyond as having a flexible financial position, with only $1.5 billion in debt on the balance sheet and more than $650 million in expected free cash flow annually over the next five years. With no part of its debt coming due until 2024 at the earliest and little chance of a dividend being initiated in the near term, we believe excess capital will be returned to shareholders in the form of share repurchases. The company said the $2.5 billion authorized in September 2015 would be used between 2016 and 2019.

Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.