Post edited 11:53 pm – March 27, 2011 by danielsparks11
When Circuit City tumbled from the scene several years ago,
Best Buy became Wall Street’s beloved, with many analysts recommending a “buy”
on the stock. How is it, then, that just several years later, Best Buy is
selling at its lowest price in two years? Essentially, the Street believes that
online retailers and a trend toward online shopping threaten Best Buy’s
competitive position. But is the threat as serious as the Street makes it seem?
Is the decline in price really a result of Wall Street’s concern for this
competition?
After looking over Best Buy's financial statements and
attempting to understand its story behind this price slide, it seems to revolve
around only several temporary issues: (1) decreased sales in TVs and notebook
computers and (2) managements decision to lower 2012 guidance. Neither of these
issues have anything to do with increased competition from online retail.
Let's take a closer look at these issues. As consumers'
appetites for flat screen TVs decreased this year, Best Buy's net sale
comparison's were damaged enough to send Wall Street into panic regarding their
beloved electronics store. In 2009, Best Buy had an incredible year as consumers
rushed to Best Buy to buy their flat screen TVs and new notebook computers. In
the end of 2010 to present, the trend for both flat screen TVs and notebook
computers decreased, both of which represented a large portion of Best Buy's
revenue. It is blatantly stated in the most recent quarterly report that this
years net sales "decrease was driven by a comparable store sales decline
of 5.5 percent, as it followed a very strong 7.4 percent comparable store sales
gain achieved in the previous year." In other words, it’s tough to make
this year look good when the last year was exceptional.
And as for the lowered guidance for 2012, this is not
surprising. Best Buy relied too heavily on the demand for flat screen TVs. Flat
screen TV sales allowed for rapid turnover of products with solid profit
margins. I praise Best Buy for lowering 2012 guidance when they knew full well
that it would encourage Wall Street to sell the stock, lowering the price.
So, the Street might claim that their reason for shunning
Best Buy is the threat from online retail, but the truth is that the reason for
Best Buy's sub-par performance is not primarily due to increased competition
from online retail, but, instead, due to the pairing of an exceptional year and
a mediocre year in which the exceptional year makes the mediocre year pale in
comparison.
Consumer electronics is a very tough business with high
barriers of entry. The strain on the industry to keep prices low and
continually meet consumer's ever-changing desires also puts a lot of pressure
on Best Buy. However, Best Buy is the established king of in-store consumer
electronics.
The fact is, Best Buy differentiates itself from online
retailing by allowing consumers to experience the technology before making a
purchase. Furthermore, it gives the buyers a hands-on shopping experience and
the convenience of having these products in their hands immediately after a
purchase. Best Buy has proven to master the art of this business model in the
past and I don't expect much to change in the future.
Furthermore, Best Buy has proven that it is capable to adapt
to rapid change, as highlighted by Star Tribune, "Best Buy may be too big
to reinvent itself, but the company has an uncanny knack for adjusting its
business model in response to or in anticipation of consumer needs. Two recent,
powerful examples include the Geek Squad purchase in fiscal 2003 and the
unveiling of Best Buy Mobile" (Wieffering, March 26, 2011).
Important Highlights:
- Best Buy has an exceptional return on invested
capital of 19%, higher than most of the industry.
- Price is at a 2 year low.
- The company has recently repurchased many of its
shares, reducing the number of shares outstanding by 8%. To reduce the shares
outstanding by 8%, Best Buy had to spend about $1.2 billion, paying about 36.62
per share. Now, with shares selling at $29, and $1.3 billion left to spend on
repurchasing shares, Best Buy will no doubt take advantage of the low stock
price and go on a shopping spree, buying itself. With that much to spend and
with the stock trading at its current price, shares outstanding will most likely
be reduced by at least another 11%!
- My estimated margin of safety is 46.9%
- Current free cash flow yield (FCF) is a healthy
12.1%.
- Its average FCF growth rate per year over the
past 5 years is 5.94%. So I consider my estimations for future FCF growth in
the DCF analysis to be conservative.
It is my opinion that Best Buy has a wide economic moat. I
am bound to find people who disagree, I am sure. Especially since 2/3 of Wall
Street analysts hold a “neutral” or a “hold” on the stock, mostly due their
belief in its lack of an economic moat. But I am confident in its moat.
And if Best Buy does have a wide economic moat, then this
business is selling at a great bargain.
Attached is my DCF analysis based on the F Wall Street
method. As you can see, I include shareholder’s equity in the fair value
valuation as Joe Ponzio does.
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