Best Buy Co. Inc. (BBY) $19.17
Best Buy is cheap. The company is not classic “trading well below book value” cheap or “sum of parts are worth more than the whole” cheap but rear-view mirror “value trap” cheap. The company trades for just 2.2 times EBITDA. Essentially if the company simply generates as much in cash flow as it did last year, you get back your full investment in less than three years and you get paid a dividend of 3.3% while you wait for this to happen (this is a simplistic view as it does not take into account CapEx or the fact that cash flow was higher than usual last year). However Best Buy in the words of its newly minted CEO is a turnaround.
Turnarounds are challenging. Turnarounds of companies saddled with debt are nearly impossible. Best Buy has $598 million in net debt on its balance sheet. In this case Best Buy has two things going for it. The company has $1.39 billion in cash on its balance sheet and a business that is still generating positive free cash flow. Net income was negative last fiscal year on account of a non-cash Goodwill related write-down but the company generated $2.5 billion in free cash flow for the full fiscal year ending March 2012.
Late last year I had a spirited exchange with my business partner about Research In Motion (RIMM). The stock was trading around $15 and I told him that it had come down from almost $70 and was trading for less than 2 times trailing free cash flow. As a Blackberry user he was intrigued and thought it could be a great buy but the stock continued to decline further and now trades for $11 after the company stopped providing earnings guidance and reported a net loss in the fourth quarter. Given the $10 billion price tag Google (GOOG) paid for Motorola Mobility and its patents, there is a good chance Research In Motion is worth a whole lot more than its current $3.9 billion enterprise value. This is one of the reasons I own $10/$11 call spreads on RIMM in my personal portfolio.
When Best Buy reported full year and fourth quarter earnings last week, the company reaffirmed its full year guidance for the current fiscal year ending in March 2013. With over $50 billion in annual revenue and 170,000 employees across 3 continents, Best Buy has several levers it can pull to right its ship. The company plans on shutting down 50 stores this year and already closed 41 as of May 12, 2012. The company will continue shrinking its physical footprint even as it opens smaller format stores that sell mobile phones.
It is not impossible to compete in a retail world dominated by Amazon.com. Best Buy saw a big boost to its revenue and earnings following the acquisition of Geek Squad but that edge has eroded with services representing just 7% of domestic revenue and 8% of international revenue. The company is also doing well in select verticals such as mobile. Focus on specific verticals can pay off. While working as the Director of IT for a San Francisco based start-up, I used to purchase equipment from Amazon.com but also picked up IT equipment from a local San Francisco store called Central Computer thanks to the depth of its inventory and focus on the computing vertical. The company has now grown to 5 San Francisco bay area locations and one location in Shenzhen, China.
Best Buy may also have an edge when it comes to appliances as high shipping costs might negate Amazon’s advantage in this area. When I wanted to buy a washer and dryer last year, I ended up buying them at Best Buy after visiting Sears and other retailers because Best Buy had the model I wanted and had the ability to install it in just a couple of days. In fact appliances represent a significant part of sales at Best Buy’s Chinese chain called Five Star.
Best Buy sells Apple products and could very well build expertise in servicing and fixing Apple computers and other Apple devices. That is just one of several strategies the company could employ to remain relevant in this digital age and I am sure the management team is probably combing through the feasibility and ROI of different strategies as part of its turnaround plan.
With Amazon.com expected to start charging sales tax for purchases in California and Texas later this year, the price advantage of shopping on Amazon.com may erode for residents of these states. A pricing survey done by Deutsche Bank found that prices for Sony and Samsung TVs at Best Buy were comparable to those found on Amazon.com.
Business Statistics & Financials:
In the first quarter of fiscal 2013 ended May 5, the company saw same store sales drop 5.3% but saw overall revenue increase 2% to $11.6 billion thanks to an extra week in the quarter this year. Beyond competition from Amazon.com, the company is also hurting from weakness in Europe and China with international same store sales falling 10.5% largely on account of expiration of government programs that helped appliance sales. The company expects a modest improvement in same store sales through the rest of the year. Domestic gross margins declined 30 basis points and international gross margins declined 180 basis points on account of weakness in the mobile phone business in the UK. The international segment, which accounts for 24% of overall revenue, generated a small operating loss of $33 million in Q1 vs. an operating profit of $295 million in the domestic segment after restructuring charges of $127 million.
The company plans to spend between $750 million to $1 billion on share buybacks in fiscal 2013. The company reaffirmed its guidance for non-GAAP earnings of $3.50 to $3.80 per share, including the impact of share repurchases and excluding restructuring costs. The company generated non-GAAP adjusted earnings of $3.64/share last year.
Restructuring charges are expected to come in between $300 to $350 million for fiscal 2013. The company expects GAAP earnings of $2.85 to $3.25 per share. Assuming they achieve the low end of their GAAP guidance, Best Buy is currently trading at a forward P/E of 6.7. Starting with $2.85 as their earnings and assuming a decline in earnings of 2% every year for the next five years, I get a value of over $24 for the stock using discounted cash flow analysis with a terminal growth rate of 0% and a discount rate of 11%. Obviously the market is taking a very pessimistic view of Best Buy.
|Stock||Symbol||Mkt Cap||EV/EBIDTA||P/B||Operating Margin|
|Best Buy Co. Inc.||BBY||6.56B||2.3||1.72||4.64%|
|Wal-Mart Stores Inc.||WMT||3.46B||7.62||0.95||5.94%|
Two insiders purchased stock on the open market over the last six months as listed below. You can view a list of all insider transactions for Best Buy here.
Mr. Mikan has served on Best Buy’s board of directors since 2008 and took over the role of interim CEO after former CEO Brian Dunn was forced to resign after an internal investigation into his personal conduct with a female subordinate.
|Owner||Relationship||Date||Cost||# Shares||Value($)||Total Shares|
|George Lawrence Mikan III||CEO – Interim||May-23||$18.24||100,000||1,823,570||106,000|
Best Buy faces several risks as it attempts to turn its business around. Beyond the oft stated risk from digital competitors like Amazon.com, weakness in Europe and China appear to be other near-term risks that could impact the company. Commitment to a large share buyback program and large acquisitions could take away from much needed cash the company could deploy towards R&D or expansion into new international markets.
I started out perceiving Best Buy as a value trap but the more I look into the company the more it feels like all the bad news is factored into the stock price and then some. Turnarounds can take time and the stock may not do much for a few months even if it does not decline further. One could pick up a position, write slightly out-of-the-money covered calls against the position and collect the dividend while waiting for the calls to expire worthless. One could also just write cash secured puts and attempt to pick the stock up at a slightly lower price. A third way to speculate would be to do near-term call spreads if you expect a sharp rebound from current levels.