Bed Bath & Beyond (BBBY) released their earnings last night and the market was severely disappointed. The stock is looking to open this morning around 8% lower than yesterday’s close after posting earnings that were flat year on year and missed expectations. More importantly, they offered lower guidance for their next quarter. The reaction is, I guess, about right given the news. It is probably a touch overdone because that is what markets do, but overall, the drop is justified by the numbers and especially by the lower guidance. The effect on BBBY itself, however, is not what concerns me. What does is the possibility that the company’s experience could be a harbinger of things to come.
Bed Bath & Beyond reports on a fairly unusual schedule; their earnings release comes just before the “official” season kicks off with Alcoa (AA). That will come in a couple of weeks, on July 8th to be exact, and there will probably be, as usual, a whole mess of analysis drawing implications for the broader market from Alcoa’s results. Three months ago, though, BBBY, in their earnings, gave a pretty good idea of was to come when they reported the day after Alcoa.
At that time, management blamed the poor performance of the preceding quarter firmly on the weather. Many thought that they had overstated the effects of the harsh winter and were simply using it as an excuse. Yesterday’s downward revision of first quarter GDP numbers for the US, to a stunning -2.9%, would indicate otherwise. It would seem that Bed Bath & Beyond had a pretty good handle on what was actually going on in the economy. If yesterday’s report and stated reasons provide the same level of advance warning about the problems faced by companies, then we could be in for a rough ride when the craziness of earnings season begins in earnest.
We have seen a remarkable run of recovery in the major US indices since the dark days of 2009. Some of this has been down to improving economic conditions. It is no secret, however, that that recovery has been somewhat of a grind. The recovery in the markets has, by contrast, been anything but. The discrepancy can be traced to several factors. Easy monetary policy by the Fed and other major central banks around the world has contributed as has the fact that we were coming off of a very low base. A large part of the move up, however, can be attributed to the most basic of reasons; companies have continued to increase earnings at a good rate.
Some of that earnings improvement is undoubtedly the result of improving economic conditions, but US GDP that has struggled to grow over 3% on an annual basis doesn’t explain the S&P tripling over 5 years. That is down to US companies doing what they are famous for, innovating, controlling costs and managing effectively to ensure decent bottom line growth. If Bed Bath & Beyond is indicative of the overall conditions that companies face, then that part of the growth equation may be turning to more of a drag than a boon.
The company reported higher revenues, with sales increasing 1.7% compared to last year. Despite that profits were, as I said, flat. There could be many reasons for that; increased investment, acquisitions or a host of others, but Bed Bath & Beyond blamed higher costs in general, particularly transportation. My immediate question was, if core costs are beginning to increase, then can US companies continue to squeeze larger and larger profits out of sluggish growth?
Once again, there is statistical evidence to suggest that BBBY management are not just making excuses but are actually giving us an early glimpse of earnings season. On June 17th we were informed that US core inflation in May ran at 2%, equal to the Fed’s much touted CPI target. It would seem that after puzzling many by refusing to budge, prices, and therefore costs are beginning to move. Furthermore, the core inflation that this number measures doesn’t include fuel and BBBY highlighted increased transportation costs in their report. For US companies, it could be even worse than that number would imply.
The market has reached the point where efficiency increases are now expected, and factored into forecasts on an ongoing basis. If those increases are no longer possible and US companies are forced to rely on demand growth for expansion of earnings, then the next month or so could be a rough ride for stocks and Bed Bath & Beyond’s troubles could just be an indicator of things to come.