BBBY’s fundamentals worth a consideration

Posted by Jack Haddad on March 31, 2008 at 9:57 am

I have followed BBBY (29.11, $7.6 billion) for years, never attracted to its “low PEG ratio” as I had believed that it was unlikely to be a 20% growth company any longer. Still, I always had tremendous respect for its operating metrics, its strong balance sheet and the consistency of its results. Well, the pendulum has seemingly swung the other way. Will BBBY never grow again? The company has no debt, $2.5 billion in tangible equity, and $377mm cash as of the seasonally-low Q3. Pre-tax margins have declined from 16% to 13% over the past two years and conservatively should be a minimum of 12% on a normalized basis. So, when they report their fiscal year in April, I wouldn’t be surprised to see estimates come down again given the macroeconomic environment and the slightly high inventory situation, but we are at least getting close to a good normalized earnings power with a very low PE to boot. As you can see in the chart below, the stock has essentially been in a holding pattern for the past 7 years, as the PE has shrunk from the 30s to the low teens. The P/S ratio has declined from 4 to 1, and the EV/EBITDA ratio is 6.8.

While i have not yet bought BBY, I recommend the following strategy: Assuming the shares open tomorrow at 29.11, I would buy at market. Simulataneously, I would write either strike 30 or strike 27.50. April strike 30 is offering a nice 1.20/contract. on a 100 share investment, this premium represents a heft return of 29% in nearly 1 month. If you cannot stomach further downside from 29.11, consider hedging your shares with strike 27.50 calls. Theyre paying a premium of 2.55/contract. That is nearly a .95/contract in intrinsic value. Both are winners. Personally, I like the 27.50 striuke because I like having the shares get called away by option expiration.

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