Operating strategy: Current Strategies and Future Implications o The functional layout of the Bed Bath & Beyond stores allows for convenient navigation through the 11 specialty stores within each superstore. The racetrack layout showcas

o In terms of advertising, if BBBY wants to increase same-store-sales as well as new-store-sales, the company will have to increase their advertising from just word of mouth and flyers with coupons. And as competition increases, BBBY could fall behind if it does not invest in advertising and promotion to distinguish itself.

* Growth strategy: BBBY is only operating in 12 states, and the market is certainly not yet satiated. There are definite continued expansion possibilities

o Again, flexibility of store size to fit the local market is to BBBY's advantage.

o Even with the new store openings, BBBY will also have to concentrate on its existing stores. Same-store-growth has to be a priority if the company wants to reach its growth goals.

o BBBY's growth should not be at the expense of its quality of products and services.

Performance Assessment:

* Bed Bath & Beyond growth and margins from 1990-1994:

o (See attached excel spreadsheet for ratio analysis)

* Performance relative to BBBY competitors

o BBBY COGS Margin, Gross Profit Margin, Operating Profit Margin, and Net Operating Profit Margin are all significantly higher than Strounds, Lechters and JC Penney

o BBBY Gross Profit Margin is 41.85%, over 10% higher than the closest competitor (Strounds)

o BBBY ROE is 33.18% and the closest competitor, JC Penney has an ROE of 18.75%

* "Off Balance Sheet" Financing Impact

o (See attached spreadsheet for adjusted income statement and balance sheet after capital lease liabilities and interest payments)

* Growth Strategy:

o Yes, BBBY's growth strategy is sustainable, at least for the foreseeable future

o BBBY has a net working capital of $54 million, enough to cover the expenditures to open new stores, at $3 million per store

o Credit facility of $20 million gives BBBY an additional way (through debt) to finance expansion/growth

* Statement of Cash Flows Assessment:

o Increasing Net Earnings from 1992 to 1994

o In 1992 and 1994 CFO does not cover CapEx, however this is not necessarily negative, because it is an investment in the future growth of the company.

o There is a net increase in cash in 1992 and 1993 but a net decrease in cash in 1994

* Sources and Uses of Cash:

o Sources: Accounts payable, Proceeds from IPO, and Proceeds from revolving credit facility; in 1994 Accrued expenses is also a major source

o Uses: Merchandise inventories, Deferred income taxes, Repayment of revolving credit facility; in 1994 Income taxes payable and Prepaid expenses are also major uses

Company Forecast:

* Drivers of future earnings include:

o Same-store sales growth

o Store expansion- number of new stores and square-foot growth of existing stores

o Macro economic factors such as new home sales, increases in consumer spending on home goods

* Drivers of future cash flows:

o Merchandise inventories

o Accounts receivable

o Exercising stock options

* Threats to future cash flows:

o Accounts payable

o Capital lease payments

o Capital expenditures

* Revolving Credit Facility: Both a source and use of cash. Already drawn down $13 million of credit, which when paid off will be a use of cash. However, there is still $7 million in credit that can be a source of cash.

* Bed Bath & Beyond's sustainable competitive advantages include:

o Economies of scale-providing quality goods at prices significantly lower than department store regular prices. Such as: private label manufacturing and ability to barter for discounts

o Customer base- the emphasis on high-quality customer service provides BBBY with a loyal customer base. As long as they continue to deliver the same quality of service, their customer base will remain strong

o 1st mover advantage allows existing superstores stores to control prime retail locations in many markets. This will serve as hindrance to incoming competitors who are left to choose only second-rate super store locations.

Initiation of Coverage:

* High P/E ratio: 42.80

* Stock Price per share: $27.38

* Networking Capital sufficient to fund future growth/expansion: 1990: $9,359; 1991: $15,593, 1992: $31,955, 1993: $34,501; 1994: $54,432

* BUY Rating:

o Balance sheet can finance growth required to justify stock price and P/E ratio: sufficient cash, can still increase leverage

Why Buy?

Even though the stratospheric P/E multiple of 37 makes us carefully consider the risks of owning BBBY, we still feel that this is a company that you should own for at least the next several years. BBBY is a fundamentally strong investment with an ROE of 33.18%. Everything about BBBY's retailing business seems to be holding its strength even under the strain of their rapid growth. As you can see below, even though sales is growing at a 30% + clip it is still managing to outpace BBBY's COS and sustaining their healthy Gross Profit Margin of 40%.

In the graph above we can see that BBBY's sales per sq. ft. remains stead y in the face of massive square footage increases. In addition to that same store sales grew at an amazing 10.6% this year.

BBBY has announced plans to grow their stores by 30% a year for the next three years. With $35 million currently in Retained Earnings and a credit line of $20 million available to them, they have adequate capital to carry out these plans. Given that BBBY's store growth has a 97% correlation to growth in the Net Earnings we are confident that these store openings will have a positive effect on BBBY's financials.

There is one issue to watch however. As is the case with most retail growth stories there is the possibility that keeping up this incredible pace could affect BBBY's margins. Keep an eye out to make sure that BBBY isn't growing sales by increasing advertising expenses, adding middle management, or engaging in price wars with competitors. We feel secure in saying that the BBBY model is less suseptable to pitfalls such as these given their model and past history of mainting costs while growing.

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