Signs of economic improvement continue. On Friday, nonfarm payroll data in the United States showed that the economy added 288,000 jobs in the month of June. This represents four consecutive months of job gains in excess of 200,000. Said another way, 997,000 total jobs were created over the past 120 odd days. Compare this to 3 years ago when 417,000 jobs were created between March and June 2011.
While the S&P 500 has appreciated close to 7.4% since the start of 2014, not all stocks have participated in the rally. The retail sector in particular has offered investors lackluster returns. Stocks including Bed Bath & Beyond Inc (NASDAQ:BBBY), Best Buy (NYSE:BBY), Staples (NASDAQ:SPLS) and Sears (NASDAQ:SHLD) are all down between 15% and 30% since the start of the year.
There are several reasons for the decline. Aside from the frigid winter that kept consumers indoors, Amazon.com (NASDAQ:AMZN) continues to build its footprint. Revenue at the company increased 23% year-over-year in its first quarter that ended in March. These two factors alone have caused retailers to discount their products and offer free shipping to keep up with evolving consumer trends.
Differentiating a value trap from an undervalued stock requires a thorough analysis of the business. Bed Bath & Beyond is undoubtedly a value investment. Though the stock is not accompanied by a dividend, shareholders can take comfort in the stock’s 10x forward P/E, 9% free cash flow yield, and debt-free balance sheet. Since the start of the year, the share price is down 26.1% due to lower-than-forecasted same-store sales results and earnings that marginally fell short of analyst estimates.
Unlike many of its retail peers, however, BBBY has posted reasonable results. For example, compare the company to another retailer, Staples. Despite similar 25% share price declines since the start of the year, earnings per share at BBBY continue to expand while SPLS’s bottom line continues to weaken. In fact, Staples’ earnings per share will contract 16% this year and 1% next year. Compare this with BBBY whose earnings will appreciate 4% this year and another 8% next. Furthermore, SPLS’s same-store sales in North America contracted 4% in its most recent quarter while BBBY’s increased by a modest 0.4%.
While investors wait for consumer spending to pick up, BBBY continue to aggressively buy back its own shares, a sign that the board feels strongly that the share price is undervalued. In the last three fiscal years, the company bought back 17% of its shares outstanding. In its first quarter of this fiscal year, the company bought back another 2.9%. At this rate, there won’t be anything left to buy in 15 years.
A second look at retail is warranted following this week’s news that activist investor Jana Partners took a 9.9% stake in PetSmart (NASDAQ:PETM), another retailer that has faced the same headwinds as its peers in the sector. The hedge fund stated that it will not only improve capital allocation but will also urge the sale of the company. Investors lauded the move, sending shares up 13% on Thursday. The position is unsurprising, given that PETM has posted attractive metrics. Interestingly, BBBY and PETM both share the same share buyback history and earnings per share growth characteristics. While PETM’s same-store sales have slowed due to competition (-0.6% year-over-year in its most recent quarter), the company has bought back 13% of its shares outstanding over the past 3 years. Furthermore, its earnings per share will grow 7% this year and 9% next.
Given BBBY’s strong operating results relative to its peers; the 26.1% share price decline in 2014; and the recent activist stake in Petsmart, a company with similar characteristics to BBBY; Bed Bath & Beyond is a value investment that will arguably accompany future share price appreciation for its shareholders.