CWS Market Review – June 22, 2012

With investing, sometimes you’re wrong even when you’re right. In last week’s CWS Market Review, I made a bold prediction. I said that Bed Bath & Beyond ($BBBY) could earn as much as 88 cents per share which was well above both Wall Street’s consensus of 84 cents per share and the company’s own guidance of 79 cents to 83 cents per share.

Well, my bold forecast was right. In fact, it wasn’t optimistic enough! Bed Bath & Beyond reported fiscal Q1 earnings of 89 cents per share. The problem is that they gave Q2 guidance of 97 cents to $1.03 per share which was below the Street’s consensus of $1.08 per share.

That’s all it took to unleash the bears. On Thursday, traders gave the stock a super-atomic wedgie. When the closing bell sounded, BBBY had lost $12.50, or 17% of its value. Ouch!

In this week’s issue of CWS Market Review, I’ll talk more about the outlook for BBBY. (Here’s a preview: Thursday’s selling was way, way, WAY overdone.) We’ll also look at the positive earnings report from Oracle ($ORCL). Put it this way: Things are going so well for Larry Ellison that he just bought his own Hawaiian island. (I’m serious.) But first, let’s try to deconstruct the damage at Bed Bath & Beyond.

Bloodbath & Beyond: 17% Loss in One Day

Let’s start with the good news. Bed Bath & Beyond reported solid earnings for the first quarter of their fiscal year (March, April and May). The company earned 89 cents per share which is a 24% increase over the 72 cents per share from last year’s Q1. That’s very good growth in this economy. Sales rose 5.1%, and the key metric for retailers, same-store sales, rose by 3%. That’s a good number although it’s down from 7% last year. The company was also helped by a tax benefit.

Bed Bath & Beyond has been buying back its stock at a furious pace. They spent $306 million during the first quarter to buy back 4.6 million shares. That’s roughly 2% of the outstanding shares. As I’ve said before, I’m not a fan of share repurchases. I’d rather see companies pass those profits on to shareholders in the form of dividends. Still, these numbers give you an idea of how profitable BBBY has been. In fact, they still have another $600 million left in the current share repurchase program. (Hey guys, how about a dividend?)

The company experienced a small drop in gross margins (40.6% to 40.0%) during Q1 which was due to the use of coupons. Still, BBBY has done a very good job of growing its margins over the past few years so I’m not concerned by a minor downtick. What’s far more important is that BBBY has a rock-solid balance sheet which includes $1.8 billion in cash, cash equivalents and investment securities.

As I mentioned last week, BBBY has made some impressive strategic acquisitions lately. They recently picked up Linen Holdings, and a few weeks ago they bought Cost Plus. Combined, these deals cost $650 million. In my opinion, these were very good moves. On an accounting note, BBBY said that once the Cost Plus deal is done, it will subtract several cents off their Q2 earnings but would be slightly accretive to second-half earnings.

Now let’s look at the bad news. On the earnings call, BBBY said they expect fiscal Q2 earnings to range between 97 cents and $1.03 per share. Wall Street has been expecting $1.08 per share. The company also said it expects earnings for the fiscal year, which is 53 weeks long, to rise by a “high single-digit to a low double-digit” rate. This isn’t news—it’s an exact repeat of what they said in April. Let’s say this means growth of 8% to 12%. Last year, BBBY earned $4.06 per share so the guidance works out to a range of $4.38 to $4.55 per share. The Street had been expecting $4.63 per share which represents growth of 14%.

The guidance is disappointing, but please, it’s hardly that dramatic. In percentage terms, we’re only talking about a few points. On top of that, we know that BBBY has been beating its estimates pretty handily for the past several quarters. Consider these stats: Last quarter, they beat their own guidance by ten cents on the low end and six cents on the high end. For Q4, BBBY topped their guidance by 20 cents on the low end and 15 cents on the high end!

Doesn’t this suggest that this company likes to lowball Wall Street? Nothing in the past few months has greatly altered BBBY’s business. Remember, these are the folks who remained profitable during an historic housing bust; not all home furnishings stores can say that.

Going by Thursday’s closing price, BBBY is trading at roughly 13.5 to 14.0 times this year’s estimate. That’s a good deal. I apologize for the dramatic price swing, but the stock market isn’t always so cooperative. Due to Thursday’s big fall, I’ve decided to lower my buy price. I now rate Bed Bath & Beyond an excellent buy anytime the shares are below $70.

Reynolds American Hits New All-Time High

Before I get to Oracle’s earnings report, here’s a reminder of why we prefer high-quality stocks—and this is why I’m not worried about Bed Bath & Beyond. Two months ago Reynolds American ($RAI) posted disappointing earnings. They missed estimates by a grand total of two pennies per share. However, as I noted at the time, they kept their full-year forecast the same (just like BBBY). Sure enough, traders ignored the important stuff and latched on to the negative news. The market knocked 5% off the stock. I said that this made no sense and we shouldn’t be rattled by these short-term reactions.

So what’s happened since then? In the last two months, Reynolds American has raised its quarterly dividend and the stock has made up all the ground it lost and then some. On Wednesday, shares of RAI hit a new all-time high. Once again, patience and careful stock selection won in the end.

Oracle Can Reasonably Be a $40 Stock

On Monday, Oracle ($ORCL) surprised us by releasing their earnings report earlier than expected. The company earned 82 cents per share for the fourth quarter of their fiscal year. Oracle had told us to expect earnings to range between 76 cents and 81 cents per share. Wall Street’s consensus was for 78 cents per share. Revenue rose 1.3% to $10.9 billion which was inline with the Street. For the entire fiscal year, Oracle earned $2.46 per share. Oracle’s board also approved adding $10 billion to the company’s share repurchase program.

Oracle’s stock responded by jumping as high as $28.75 on Tuesday. After Thursday’s market downdraft, the shares closed at $27.81 which is still a very good bargain.

On the earnings call, Oracle said it sees fiscal Q1 earnings ranging between 51 and 55 cents per share. I think that’s probably a bit too low. Right now, Wall Street thinks Oracle can earn $2.66 per share for the entire fiscal year. That means the stock is going for a little over 10 times earnings. I honestly think Oracle can be a $40 stock. I’m raising my buy price to $32 per share.

That’s all for now. Next week is the final week of the second quarter. Can you believe the year is already half over? Historically, this has been a good time for stocks. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

P.S. I recently sat down for an interview with Brian Richards of The Motley Fool. It was nice to have time to give detailed answers to questions on investing. You can see clips of our talk here, here, here, here and here.

Posted by on June 22nd, 2012 at 5:33 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.