Is This Big Box Retailer Back on Track?

Marshall 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) appears to be back on the road to glory, question is, where does the road end? The company is up over 100% year to date, with the big news of late being the fact that Best Buy is looking to open up mini-Samsung stores inside its locations, sending shares up 10% in a single day. However, will the idea of having Samsung stores really add that much value?
One of the big problems for Best Buy is its declining margins, which are a result of declines in comp store sales. The retailer's adjusted gross margin fell 60 basis points last quarter year over year to 22.6%. Over the last five years, both Best Buy and GameStop (NYSE: GME) have managed to grossly under-perform the Dow Jones Consumer Electronics Index.
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However, over this time period, GameStop has averaged a much better operating margin and return on investment. GameStop's 5-year average return on investment is 7.7%, with Best Buy averaging 5.2% and RadioShack at 6.8%. The 5-year average operating margin for GameStop 11.6%, with Best Buy at 5.2%.

As far as hedge fund interest for Best Buy is concerned, Jeffery Vinik of Vinik Asset Management has the most valuable position in the retailer, with a $92 million value, but accounting for only 2.7% of its total 13F portfolio (check out Vinik's cheap picks).
RadioShack (NYSE: RSH) is another struggling retailer. Like Best Buy, the company managed to post better than expected fourth-quarter results. However, just like the decline in demand at Best Buy, RadioShack is seeing similar pressure due to changing customer preferences related to buying online. 
During the fourth quarter of 2012, the comp store sales for company-operated stores and kiosks were down 7% year over year. What's more is that its key revenue contributor, U.S. company-operated stores were down 7.8% year over year. 

RadioShack's over-reliance on wireless is in itself a negative, where margins are lower and cost cutting is limited. The one positive is that industry consolidation will likely be a part of the company's drivers going forward, and with a market cap of less than $500 million, RadioShack could easily be a top target. 

Going into 2012, RadioShack had 14 of the hedge funds long the stock, a decline of 13% from the previous quarter (see how other hedge funds are trading RadioShack). 

GameStop has moved into the top spot as Best Buy's top competitor. Although sales were flat last quarter on a year over year basis, cost cutting helped the company see EPS up 25% year over year. Helping drive Gamestop and the video game industry over the interim will be the release of Grand Theft Auto V and next-gen game consoles. Gamestop is also branching out to help develop a better revenue mix, which includes adding digital gaming to its product portfolio.
Zacks expects console hardware and software to decline in single-digits in fiscal 2013, but the launch of one or two new consoles will drive 2014 console hardware and software growth between 20% and 30%, Whereas, Best Buy saw nearly 28% of the hedge funds owning the stock at the end of the third quarter dumping the stock during the fourth quarter, Gamestop saw a 5% increase in hedge fund owners (check out all hedge funds flowing into Gamestop).

By the numbers 
From a valuation standpoint, Best Buy has become rather expensive after its run up. The retailer now trades at 9 times forward earnings, compared to major peer GameStop's 8 times. 
On a price to free cash flow and a enterprise value-to-EBITDA basis, Best Buy is again expensive. Best Buy trades at 11.3 times free cash flow compared to Gamestop's 6.9 times; It also trades a EV/EBITDA multiple of 4.15, Gamestop is at 3.53. 
So is the entire industry a sell? Or is it just Best Buy? The other major industry players have solid expected EPS growth rates. Notable retailers Conns and hhgregg are expected to grow 5-year EPS at an annualized 15% and 12.5%, respectively.
Analysts are not impressed with Best Buy's EPS growth. The five-year expected EPS growth rate is a negative 3%. This is even less exciting when looking at GameStop's 10%. What's more is that GameStop has a dividend yield of 3.6%, versus Best Buy's 3.1%. 

Don't be fooled

Best Buy appears to be getting ahead of itself from a valuation perspective, but GameStop could be an interesting pick. Best Buy has more than doubled year to date, thanks to better than expected holiday and fourth number earnings, not to mention their new partnership to offer Samsung store-in-stores. But I think the current stock reflects too much optimism in the timeliness of a turnaround.  

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and RadioShack. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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