2023-08-09 17:44:25 ET
Summary
- Best Buy has successfully adapted to the digital shift in consumer behavior, with digital sales accounting for a significant portion of its revenue.
- The introduction of paid membership programs is expected to contribute positively to Best Buy's financial performance in the coming years.
- While Best Buy has made improvements in various areas, its financials, valuation, and growth prospects do not justify a buy recommendation.
- Tightening of earnings & cash flow may lead to a reduction in shareholder benefits like dividends and buybacks.
Investment Thesis
Best Buy ( BBY ), a longtime heavyweight consumer electronics retailer, is a well-established business with solid management and decent prospects. However, though the enterprise has made steps to ensure a competitive position in the intensely competitive space, I do not find the firm's future promising enough to warrant a buy at its current price. Best Buy, to me, is nothing more than a company with stability and a decent dividend. I recommend a HOLD in Best Buy for the following reasons.
Earnings
Before I talk about more qualitative factors, I'd like to take a look at Best Buy's recent performance. Q1 2024 earnings were largely in line with expectations -- albeit with small beats on EPS and a small miss on revenue -- but the trends discussed do not exactly inspire confidence in the immediate future for Best Buy. Here are some figures for reference.
Comparable sales have declined low-double digits since last year across virtually all of Best Buy's segments. This trend is likely to continue based on the company's own forecasts and the broader macroeconomic environment. While the business is still obviously profitable, and at the end of the day these issues are transitory since consumer spending will almost certainly bounce back once rates have been lowered and inflation controlled, I fear that the situation may have some negative effects on Best Buy's dividend. Given that Best Buy isn't exactly a growth stock, its appealing dividend is one of the primary reasons to own BBY, so this is somewhat concerning.
Net income in 2023 was at a low, and, despite minor efficiency increases that have led to higher gross margins in Q1 2024, first-quarter earnings have fallen about 28.5% YoY. Given that shareholder benefits like dividends and repurchases are one of BBY's most appealing factors, decreases in earnings given a front-loaded debt schedule and mediocre liquidity (.98 current ratio, .24 quick ratio, and a 2.69 degree of operational leverage) suggest to me that these perks may not be guaranteed as we move further into FY 2024. Cash flow was also net negative in 2022 and 2023, which hasn't helped matters.
Seeking Alpha ranks BBY's dividend safety as a D, and I am inclined to agree that despite a solid yield, dividend seekers should look elsewhere.
Looking ahead to Q2, with results being released later this month, not much is likely to change. While comparable sales declines are projected to be milder, at 6-8%, this does not really change much of anything in my view. The same problems outlined above still remain, especially since rate drops are unlikely until 2024 at the earliest. Of course, I don't have a crystal ball, but even Best Buy's own projections for FY 2024 suggest declines on the top and bottom line compared to 2023. Limiting cash flow further jeopardizes one of the primary appeals of owning BBY in my eyes. The preponderance of downward revisions for Q2 only give me more confidence in this idea.
The Good
Having said all that, I would still like to discuss some of the positives about Best Buy.
Digitization
One of the most notable changes in Best Buy's business model in recent years is a pivot towards digital fulfillment accelerated by the pandemic. Best Buy now sees about 1/3rd of its sales digitally, up from 19% prior to 2020. Of course, this change has occurred to varying degrees industry-wide, as there has been a fundamental change in the shopping habits of consumers, but Best Buy has adapted adequately. This has also enabled the firm to increasingly leverage its stores for fulfillment and post-sale services.
Morningstar suggests that the margin drag from digital orders is likely to prove permanent, and I'm inclined to agree (even though Best Buy's margins have never been record-setting). On the other hand, the uptick in digital orders does presumably lead to more revenue from the high-margin service category. Still, though, margin contraction is important to keep in mind -- even if it hasn't quite been a long enough time to ascertain a material effect.
Regardless of any negatives, the digital channel is necessary for any retailer to remain competitive, and it does have potential upside due to the side effect of increased membership in loyalty programs and the aforementioned service segment. This should, after digital sales stabilize, enable Best Buy to compete for online order volume that it may have otherwise lost prior to the pandemic.
As a bit of a tangent, Best Buy has been trying out new store formatting , likely to promote its core competency (and slightly higher margin) in-store shopping. While this isn't exactly groundbreaking, it's good to know that management intends to keep innovating to keep top-line growth stable.
Paid Membership Programs
I hate to speak about these in nebulous terms, but hard data is hard to come by and the programs are too new to make definitive assumptions.
My Best Buy Plus and My Best Buy Total are paid memberships that customers can use to gain various benefits across Best Buy's service & product offerings, including 24/7 support, repair discounts, exclusive sales, and more. I anticipate that, while not earth-shattering, these should turn out to be solid contributions to Best Buy's top and bottom lines in the coming years.
I'll admit that II initially questioned the purpose of a loyalty program designed to increase the frequency of purchases in a high-price, low-frequency category, but the change from a single program to a 3-tiered program and Best Buy's own optimism on the project (see their earnings calls for details) have given me a more positive view on the initiative.
While I do not expect there to be a substantial immediate effect from these programs, I am bullish on the prospect of increased engagement with the firm's most dedicated customers, which should have at least a minor effect on spending and frequency.
Minor Positives
Other things that speak to Best Buy's Benefit are improved shipping logistics, with 35% of stores now accounting for about 70% of ship-from-store volume, which I anticipate will lead to minor margin improvement on small e-commerce orders.
Best Buy Health, which the uninitiated can read a bit about here , is something I've been tracking for a while. Though the concept intrigues me, I find the industry to be a bit too competitive to be overly optimistic about its future. Certainly something to keep an eye on, though.
The Bad
Digitization
I know, I know, I'm putting digitization under both umbrellas. I'll keep this one short and sweet. Service and accessory purchase rates remain higher on in-store purchases, which may serve as a modest headwind since the digital channel is likely to be perpetually a bigger portion of sales than ever.
Financials
While a soft 2023 was largely the result of extraneous factors, including a decrease in pent-up demand from the pandemic, a shift in spending toward service industries, and a generally oppressive macroeconomic environment, some of these headwinds are likely to continue into the future.
Due to the relative stagnancy of offline sales at Best Buy and other brick-and-mortar retailers, if Best Buy is unable to continually capitalize on the digital medium and optimize its omnichannel capabilities I believe it is prone to experiencing subpar growth.
Of course, Best Buy is a stable company, but I don't see a concrete path toward market-beating growth at any point in the near future. The retail industry has historically not been the most "exciting", and as such I find it highly unlikely that Best Buy's earnings will increase at anything higher than a low-single-digit figure. The company's initiatives, while sound, do no more than perhaps maintain Best Buy's current competitive advantage. I also see no convincing catalyst that would sway market opinion on the horizon, outside of the usual minor swings.
Some of these symptoms aren't specific to Best Buy, and in a vacuum Best Buy is certainly not the worst investment. I see no issues with holding it. However, I am certain that investors may be better served putting their money elsewhere for the time being.
Valuation
The last proverbial nail in the Best Buy coffin for me is its mediocre valuation. While not offensive, Best Buy is not at a low enough price to find significant upside.
Best Buy's price to earnings has fluctuated over the years, but the mean of this range has been 13.47. Given a current P/E of 13.55, it's difficult to say there is any margin of safety to call Best Buy undervalued.
Compounding this, FactSet analyst composites (21 analysts) put a fair price for BBY (within 1 standard deviation of the median $77) between ~$67.50 and ~$86.50. Again, no justification here.
Seeking Alpha's valuation page tells a slightly more promising story, but it is exceedingly difficult to get a publicly traded direct comparison to Best Buy's competitors given its unique specialty as a technology-exclusive retailer. Even though these metrics do beat the broader industry, the other factors I've mentioned including BBY's historical pricing suggest to me that Best Buy is not significantly undervalued.
The Bottom Line
Best Buy has adapted well to new market conditions, working to improve its omnichannel capabilities, and is taking steps to improve wallet share through membership programs. It also offers a fairly high dividend yield of 4.6%, though this dividend's safety is far from guaranteed. It is clear to see that the business model is stable and sound.
However, despite all of this, I do not find there to be sufficient wiggle room in Best Buy's valuation or satisfactory growth tailwinds to warrant a buy in Best Buy when there are other businesses out there. For these reasons, I suggest a HOLD.
For further details see:
Best Buy Is Taking Steps, But Has A Short Stride