2023-11-21 12:45:28 ET
Summary
- Facing a 6.9% revenue decline and a 7.3% drop in domestic sales, Best Buy grapples with economic challenges, questioning the attractiveness of its 5% dividend yield.
- In a deal-focused consumer environment with inflation fears, careful spending choices impact Best Buy's sales. Macro factors create uncertainty, affecting consumer confidence.
- Despite an appealing valuation, economic concerns and lowered guidance prompt a closer look for investors anticipating a consumer recovery.
Introduction
It's time to talk about Best Buy ( BBY ) , one of the most interesting stocks in the consumer cyclical space. On September 11, I wrote an article titled How Juicy Is Best Buy's 5% Yield? In that article, I wrote that we're dealing with a good company in a bad environment, which makes even its well-covered 5% dividend yield not that attractive.
Here's a part of my takeaway:
Best Buy faces significant challenges in the current economic environment. While it's not a bad company, it struggles to offer compelling long-term returns, especially compared to other options. The 5% dividend yield is tempting, but it doesn't outweigh the risks.
While Best Buy's strategies are commendable, they may not be enough to navigate current challenges.
Unfortunately, I get to confirm that thesis in this article, as the company just reported its 3Q24 earnings, which showed significant topline weakness and poor guidance.
Although I like how Best Buy is positioning itself for the future, I cannot get myself to turn bullish just yet, as there's too much uncertainty and other plays that I would prefer over brick-and-mortar retail right now.
So, let's get to the details!
It's Tough, Very Tough
The enterprise revenue for the third quarter was $9.8 billion, marking a 6.9% decline on a comparable basis.
- The Non-GAAP operating income rate decreased by ten basis points to 3.8%.
- Non-GAAP diluted earnings per share also declined by 6.5% to $1.29 compared to the previous year.
To dig a bit deeper, enterprise comparable sales showed a decline in August by approximately 6%, September down 7%, and October down 8%, which is not a good trend - to put it mildly.
However, despite sales below plan, the non-GAAP operating income rate exceeded the outlook by 40 basis points due to lower SG&A.
Appliances, computing, home theater, and mobile phones contributed to the decline, partially offset by growth in gaming.
Unfortunately, SG&A still increased as a percentage of total revenue. The good news is that this did not keep the operating margin from rising.
Furthermore, in the Domestic segment, revenue decreased by 8.2% to $9 billion, with a comparable sales decline of 7.3%.
The International segment experienced a 3.4% revenue decrease.
Thankfully, the Domestic gross profit rate increased by 100 basis points to 22.9%, attributed to membership offerings, improved product margin rates, and lower supply chain costs.
Additionally, the profit-sharing revenue from the credit card arrangement performed better than expected, contributing positively to the gross profit rate.
The expectation is for this trend to continue in the fourth quarter, but there's anticipation of it becoming a pressure on the gross profit rate in the following year.
Having said all of this, before we go into detail regarding its outlook and efforts to improve the business, Best Buy also commented on the health of the consumer.
Last month, consumer confidence took another hit, as consumers are more fearful of inflation and anxious about the future.
Best Buy is seeing these trends as well.
During its earnings call, the company noted that despite a robust spending environment, consumers are making careful choices and trade-offs in response to inflationary pressures on essentials.
The company highlighted a deal-focused consumer for the upcoming holiday season, expecting shopping patterns to align more closely with historical holiday periods.
Best Buy also acknowledged the uncertainty in the macro environment, with both positive and negative factors impacting consumers unevenly.
While the job market remains strong, there are indications of declining consumer confidence, increased debt, and reduced savings.
The company is right, as the bottom 80% has run out of pandemic-related excess savings.
So, what does this mean going forward?
What's Next?
Looking ahead, the company sees opportunities for industry stabilization and potential growth in the consumer electronics sector next year.
They anticipate continued replacement of technology driven by innovation and identified macro trends such as cloud, augmented reality, and generative AI as factors that could drive business opportunities in the coming years.
Unfortunately, this did not keep the retailer from lowering its full-year guidance.
As summarized by Seeking Alpha (emphasis added):
Looking ahead, Best Buy lowered its comparable sales expectations for the holiday quarter. The company now expects FY24 revenue of $43.1B to $43.7B vs. a prior outlook for $43.8B to $44.5B and the consensus estimate of $44.1B. EPS is expected to land in a range of $6.00 to $6.30 vs. $6.00 to $6.40 prior and $6.19 consensus .
Although Best Buy cannot change the macro environment, it focuses on areas it can impact.
For example, its membership program continues to bear fruit.
In the third quarter, Best Buy's 3-tiered membership program contributed positively to operating income rate expansion, with 6.6 million members, a 35% increase in new paid members, and promising retention rates.
As I discussed in my last article, different tiers cater to diverse customer segments, which makes sense, as the company is able to retain customers based on their specific preferences and willingness to pay for it.
In general, I believe that special membership programs and tailored advice/services are the way to keep brick-and-mortar stores alive. After all, the basic service of selling electronics to customers can be done online.
Best Buy also continues to evolve omnichannel capabilities, introducing Best Buy Drops for app users.
Virtual sales associates contribute to higher conversion rates and average order values. Collaborations with Talk Shop Live explore online shopping events.
Related to this, the supply chain is optimized for speed, predictability, and choice.
- Ship-from-store volume decreased, with 62% of e-commerce small packages delivered from automated distribution centers.
- Partnerships with DoorDash and Instacart enhance delivery options.
On top of that, Best Buy is refreshing stores, adjusting gaming spaces, and collaborating with partners like LEGO and Therabody.
Also, as I expected, the company plans strategic store openings and closures, focusing on enhancing customer experiences and optimizing inventory management.
Given the challenging macro environment, these incremental changes are the way to go.
Valuation
- If you believe the economy won't get much worse (soft landing scenario), Best Buy is very cheap.
- If you believe the economy is in for more weakness, Best Buy is not yet a buy.
Let me elaborate on that.
Looking at the data in the chart below, we see that BBY is trading at a blended P/E ratio of 10.7x. Going back two decades, the normalized P/E ratio is 12.9x, which is fair for a company with consistent double-digit annual EPS growth (albeit with cyclical interruptions).
This year, EPS is expected to decline by 12%, followed by an expected recovery of 7% and 14% in the 2025 and 2026 fiscal years, respectively.
Purely based on these numbers, a return to 12.9x earnings by FY26 could result in 22% annual returns, including its 5.4% dividend.
This makes the valuation quite attractive.
The problem is that I do not trust these expectations, as I am far from convinced that consumer sentiment will show a meaningful improvement anytime soon.
That is why I prefer to focus on other areas for the time being.
Nonetheless, because of its valuation, I'll stick to a Neutral rating. The company is too strong for a Sell rating, yet it has not suffered enough for a Buy rating.
That said, as a lot depends on the economy, investors who believe we're close to a consumer recovery may want to take a closer look at the BBY ticker.
For further details see:
A Best Buy It's Not