Bonds serve a different purpose than stocks. Stockholders are partial owners of the company. Bondholders are creditors. So, it’s not surprising that stocks and bonds will react differently to the same piece of news.
For instance, two weeks ago BBBY's quarterly earnings failed to meet analysts’ expectations. In response, the stock plunged 34% to $14.59 from $22.20. How did the bond market take the news? The bond fell just 6% to $86.56 from $92.21.
In the 1980s, Bed Bath & Beyond (“BBBY”) helped pioneer the concept of the superstore. But with the emergence of online shopping, BBBY failed to keep up with the Millennial generation’s shopping preferences. Instead, it heavily relies on promotions and coupons to drive traffic into its stores. For a while, this marketing strategy worked, until it didn’t.
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BBBY management blamed the recent sales drop on supply chain issues, inflation, and the inability to get people into its stores without heavy promotions. BBBY essentially acknowledged that its strategy of promotions and coupons is not sustainable. This means BBBY needs a new way to attract customers, such as online marketing strategies. The supply chain issues should clear up eventually, but the second and third reasons are major concerns. As management warned on its earnings call, if cost inflation is permanent, BBBY’s operating conditions could get worse and affect profitability.
Given this backdrop, it is not surprising that the stock sold off 34%, while the bond price only declined 6%. This shows how stocks and bonds are different. While BBBY equity holders are concerned about the company's growth and operating margins, BBBY bondholders are concerned about solvency and the ratio of assets to liabilities.
Based on BBBY’s latest quarterly report, the company’s book value is roughly $934 billion. That means there are enough assets to cover its $5.1 billion in total liabilities today. However, this asset coverage ratio has moved in the wrong direction over the last five quarters. The stress of operating in a post-COVID world has eroded BBBY’s book value. The bondholders have been patient in giving management a chance to reverse this trend with the vaccine rollout and return of normality.
There are three possible scenarios here.
That BBBY can turn around the direction of sales over the next two quarters and lift the prices of both its stock and bonds.
BBBY continues to struggle, but sales stabilize. This could continue to pressure the stock price. In this scenario, bond prices could stay flat or drop a bit to reflect the difficulties that the company is facing. Bondholders want extra compensation for taking this risk.
BBBY is facing a challenge larger than management perceives. The stock price will continue to fall, if the markets believe that BBBY will need some kind of restructuring. The bond price will follow a similar pattern, as the natural buyer of the bonds will be investors focused on distressed bonds.
In conclusion, bonds move differently from stocks because the concerns of bondholders and stockholders are different. We are neither recommending you buy BBBY bonds, nor discouraging you, just helping you understand why they move the way they do. But the next time you see a stock tank, just remember that the bond story can be different.
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