The demise of Linens 'n' Things never really amounted to an opportunity for home-goods retailer Bed Bath & Beyond (NAS: BBBY) to capitalize, as the recession weighed heavily on consumers who kept their purse strings drawn tight. But tight financial management, a clean balance sheet, and a business that threw off a lot of cash -- Bed Bath & Beyond generated nearly $1 billion in free cash flow in 2011 -- allowed shares to drive to an all-time high in early April.
Now the home-furnishings king is going a little off the beaten path and is buying smaller rival Cost Plus (NAS: CPWM) in a $550 million deal. It's not the price tag that has me worried, as Bed Bath & Beyond can pay for it with the spare change in its back pocket, but rather it's entering a business where it doesn't have as much expertise.
Off on a tangent
In addition to being a home-goods seller itself, which should be a neat fit with the types of products Bed Bath & Beyond sells at its eponymous stores as well as its Christmas Tree Shoppes division (where you won't find a single Christmas tree anywhere), Cost Plus also considers itself to be very much a grocer, as 39% of revenues last year came from consumables.
It's that sort of tangent that has me worried, though admittedly I castigated Bed Bath & Beyond management over its purchase a few years ago of buybuyBaby, a clothing and furnishings store for infants and toddlers, and that seems to have worked out well for it. Of course, my criticism also had just as much to do with bailing out a director's relative who owned the chain as it did with concerns of "diworsification."
Consumables have been a growing business for a number of retailers, particularly discounters where Big Lots, Dollar Tree (NAS: DLTR) , and others used them to attract customer foot traffic. Food and beverages account for 30% of Big Lots' revenues and more than 50% of Dollar Tree's total. Though they drive return visits, they tend to be lower-margin items that could pressure profits if enough higher-margin goods aren't sold.
Yet because they don't offer as broad of a selection of items as does a supermarket, there's a limit to the incremental benefits they provide. Big Lots found that out recently, as it lost nearly a quarter of its value in one day after it said comps would come up weak because consumables weren't driving customers to its stores in the numbers they expected. In fact, the segment has been the discounters' biggest anchor for the past few years.
Not surprisingly, customers have been instead shopping for groceries at mass merchandisers like Wal-Mart (NYS: WMT) and Target (NYS: TGT) . Grocery items accounted for 55% of Wal-Mart's sales last year, up from 53% in 2010, and while they amount to just 19% at Target, that's up from 17% the year before.
The saving grace for Bed Bath & Beyond here is that as it closes in on $10 billion in annual sales, Cost Plus' $374 million in consumables sales are just a rounding error for it. Even if the whole business went bust it wouldn't hurt performance very much.
The two have been experimenting with selling consumables apparently since 2010, but it must have been a very small test, since it's never come up before in any SEC filings. Cost Plus, however, noted this past quarter that it was in the midst of a four-store pilot with its new owner that offered the full breadth of products it sold in a store-in-a-store concept. Bed Bath & Beyond must have liked the response since it ended up buying the whole company.
That's par for the course with Bed Bath & Beyond, though, as it bought Harmon Face Values years ago and now operates a combination of stand-alone units and store-in-store concepts.
Growth by acquisition
While Cost Plus looks like it should be a good fit, even with the addition of consumables to the mix, the fact that Bed Bath & Beyond had to look outside its own business for growth opportunities lends credence to the suggestion by some analysts that growth is slowing.
Bed Bath & Beyond has often said it believes it can comfortably operate 1,300 stores nationwide. With fewer than 1,000 already in operation and opening just 40 to 50 stores a year, it would seem it should have had plenty of room and time to grow internally, but this move makes it seem as though even management doesn't think it's enough.
After BB&Y's fourth-quarter results, analysts at Canaccord Adams said it marked the first time the home-furnishings retailer lost market share, primarily because its Internet presence is limited. I'll admit I'd rather see them sinking half a billion dollars into making a robust online e-commerce hub, as it's amazing that in 2012 a retailer as large as BB&Y doesn't let you buy anything online from its Christmas Tree Shoppes unit.
The Foolish bottom line
Cost Plus will be bringing nearly $1 billion in revenues with it(and around $116 million in debt), but also a spotty record of profitability: It's primarily only able to generate positive earnings in the fourth quarter, and only lately has it been enough to offset the losses generated the rest of the year. With its management staying on board, Bed Bath & Beyond must be confident the team is capable of continuing the turnaround program it started. Some analysts think it's laying a heavy real estate burden on the retailer.
In total, then, the acquisition of Cost Plus looks like it could be a net plus for BB&Y, as the higher-risk portions of the deal seem small enough not to wreck the entire operation. But let me know in the comments section below or on the Bed Bath & Beyond CAPS page if you agree this should work out for the home-goods retailer.
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At the time thisarticle was published Fool contributorRich Dupreyholds no position in any company mentioned. Check out hisholdings and a short bio.Motley Fool newsletter serviceshave recommended buying shares of Bed Bath & Beyond and creating a diagonal call position in Wal-Mart Stores. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.