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Bed Bath & Beyond ratings still at risk
admin | October 12, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Bed Bath and Beyond was downgraded by Moody’s to the lowest level of investment grade. Same store sales remain on a downward trend and analysts forecast further margin erosion through 2019. A further downgrade could pressure spreads wider on two longer maturity issues, which still trade well inside of similar maturity, high yield L Brands debt.
Sales fall and margins erode
When we last wrote on Bed Bath & Beyond (BBBY) the company’s ratings were at risk given its poor fiscal 2Q results and the lack of stabilization to both the margin and same store sales (SSS). The retailer had just posted its sixth consecutive quarter of negative SSS and the last twelve months (LTM) EBITDA margin had fallen to 7.6%, down from 8.7% at year-end and 11.7% in fiscal 2016. Market analysts are forecasting further margin compression, with consensus projections of EBITDA margin for year-end of roughly 6.2%. The drop in EBITDA has spiked lease adjusted leverage to roughly 4.1x, which is above the threshold for investment grade ratings and on par with L Brands Inc. (LB – Ba1/BB).
Management moved to capital preservation mode and backed off considerably on shareholder remuneration in an effort to build cash on the balance sheet during the quarter. The balance sheet and liquidity appears good – the company has roughly $1.1 billion of cash on hand relative to $1.5 billion of total debt as well as an untapped $250 million revolver – but it was not enough to stave off a downgrade.
Moody’s downgrades to Baa3
Moody’s downgraded BBBY’s senior unsecured rating one notch to Baa3 with a stable outlook. The agency stated that the move reflected an acceleration in the decline of gross margins based on higher coupon expense, lower merchandise margins, increased shipping expense and higher selling, general and administrative expense (SG&A). The negative SSS exacerbates the impact of margin pressure and contributed to its decision to downgrade. Moody’s analysts forecast that leverage will now remain elevated for longer than originally projected while EBIT/interest has dropped to the 3.0x area. The stable outlook reflects Moody’s expectation that SSS remains relatively flat and that management will refrain from share repurchases in an effort to conserve cash. However, the ratings could be downgraded further if the negative trend in SSS accelerates and the margin decline fails to decelerate in 2H18.
Is S&P next?
S&P downgraded BBBY’s senior unsecured rating to BBB- with a negative outlook back in April. At the time, S&P noted that the negative outlook reflects their expectation that they could lower the rating further if BBBY fails to stabilize operating performance. S&P estimates were for a 130 bp decline in the EBITDA margin in 2018 and a further 70 bp decline in 2019. Year-to-date margin has already fallen 110 bp; using the street estimate of 6.2% by year-end, BBBY’s EBITDA margin is expected to decline 250 bp in 2018. Forecasts are for Bed Bath and Beyond to suffer an additional 60 bp of margin erosion in 2019.
Relative Value
The bonds trade as if they are already a fallen angel, but the two longer issues – the BBBY 4.915% 8/1/34 and BBBY 5.165% 8/1/44 – have comparatively more downside risk. The BBBY 3.749% 8/1/24 trades roughly 25 bp wide (g-spread) to LB 5.625% 10/15/23, while the BBBY 4.915% 8/1/34 and BBBY 5.165% 8/1/44 are trading considerably through LB on a g-spread basis. Part of the reason the longer dated bonds trade through LB is their deep dollar discount prices: BBBY 2034 at $73.5 and BBBY 2044 at $70, compared to LB 2035 at $84 and LB 2037 at $81. The optical cheapness is probably not enough to provide significant price support on a downgrade to high yield.
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