Wait Before you Buy this Retailer
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Best Buy (NYSE: BBY) faces fierce competition on many of its business fronts. Its online sales are directly impacted by Amazon.com (NASDAQ: AMZN) and its constant efforts at expansion into different electronic retail sectors. It’s hard to find a product that Best Buy lists that Amazon does not, and often much cheaper. Additionally, the new fleet of electronics involves many consolidated electronics devices—iPads, iPhones, and their competitors—instead of the former fleet of gaming consoles, personal organizers, phones, and personal music devices.
In the face of this, Best Buy remains the most competitive brick-and-mortar electronics retailer. However, I recommend a hold position for the stock, both 12-month and 3-year. I am skeptical about its long-term prospects until it enacts a strategy to weather these major concerns. Consumers simply tend to purchase electronics online at the cheapest price and use downloaded media. Best Buy needs to respond to this.
As a somewhat longer-standing business, Best Buy’s current price of about $20 is a letdown: The price was a little under $60 only 6 years ago, and the recent trend downward began even before the beginning of the recession in 2008. Year-over-year, Best Buy’s share price is down 40% from the first quarter 2011. However, Best Buy has matured. The price/book ratio is at around 1.67, which falls within the inner three quintiles of the consumer retail sector. The 200-day moving average is steeply falling for the stock, though shares are currently trading at slightly under the 200-day moving average. In all, I think Best Buy is only slightly undervalued, and I think there are more attractive options (discussed below) at the same price with a larger upside.
Earnings and Leadership
Best Buy’s first quarter 2012 earnings came in $0.46, a decline from $0.53 in the first quarter 2011. Their total profit per share for the first quarter 2012 was $0.72, beating the Street’s estimate of $0.59. Much of this can be attributed to economic improvements after the dip in 2011.
The future of Best Buy presently lies in the hands of future leadership. In a recent conference call, interim CEO Mike Mikan noted that he intends to drastically rethink the overall business plan of Best Buy, remarking that there will be no “sacred cows.” Change is already on the way. Best Buy will be closing 50 of its unprofitable big-box stores and opening over 100 Best Buy Mobile boutique stores. This will, at least, lower the cost structure for the company’s retail branch, which is in fierce competition with Wal-Mart (NYSE: WMT), a store that, like Amazon, offers a full range of consumer goods.
Specialization in electronics has proven to be problematic for retailers. Gamestop (NYSE: GME) is likewise facing a fair amount pressure in the current market. Gamestop, however, might make a more compelling buy, as it is currently trading at around $20. A conservative target of $26 per share is justified by Gamestop’s game-return program and lower cost basis—the small boutique format is cheaper.
But turning to boutiques is not necessarily a cure-all. RadioShack is currently in the middle of retail woes, losing $0.08 per share in the first quarter 2012, compared to earnings per share of $0.30 in the first quarter 2011. In the boutique business, it’s a competition to see who delivers better margins. Best Buy’s operating margin came in at about 3.4% for the first quarter 2012, down from the average in 2011 of 4.2%. Indeed, RadioShack has had some of the best margins in the business, but Best Buy’s recent push into this boutique market is challenging that. Additionally, it is impossible to sell appliances, which are high-margin products, in a boutique—10% of Best Buy’s floor space is occupied by appliances that account for 5% of its (highest margin) sales.
Online Retail Wars, TVs, and Apple
And then there’s the internet. There is an order-of-magnitude difference between Best Buy and Amazon: Amazon’s market capitalization is around $95 billion, and Best Buy’s is around $7 billion. In all, Amazon has the world’s largest consumer universe at its fingertips, directly snagging customers from Best Buy. When Circuit City went out of business, Best Buy failed to recover significant amounts of market share. It is hard to put numbers to the issue here: Best Buy’s in-store experience is sub-par, and the alleged “expertise” of the in-store minions is not particularly compelling. Thus, customers are increasingly turning to Amazon, where they know that free shipping and consistently competitive prices await.
Of course, many still find it convenient to shop for large products like TVs in person. With Geek Squad, Best Buy stands to sell both a product and a service with many customers. Again, there is competition on this front. Target (NYSE: TGT) has recently made its TV displays more apparent in store, and Wal-Mart now has a Geek-Squad-like service in the works. Best Buy was one of the first stores that featured a mini-Apple store. However, Target has recently decided to drop the Amazon line of readers for a new in-store Apple boutique.
Best Buy’s debt is investor grade, but there have been some concerns lately, with S&P putting its BBB- rating on watch with negative implications. Its debt/capital ratio is 33.6%, and the company leases most of its stores and distribution facilities. It owns about 55 out of 1,103 stores. The company authorized a $5 billion share buy-back agenda in June 2011. It also returns value to share holders via dividends, paying $0.58 in 2011. Considering the company’s long-term presence in the consumer electronics market, both the dividend payments and debt ratings seem on par, despite the challenges now facing Best Buy.
Best Buy has one of the greatest legacies in the business. However, investors need to consider whether there is really a place for a company that manages stores selling solely consumer electronics. These stores are, additionally, supported by a mediocre and not terribly useful website. I encourage investors to wait out the significant changes in management that have already started in the departure in two of the company’s CFOs. Hopefully some sacred cows will go as well.
This article is written by R. Brian Tracz and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Amazon.com, Best Buy, and GameStop. Motley Fool newsletter services recommend Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.