Best Buy – The Dying Retailer?

By Chad Henage - May 31, 2012 | Tickers: AMZN, BBY | 0 Comments

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I know that many analysts believe that Best Buy (NYSE: BBY) is squarely in the sites of Amazon.com (NASDAQ: AMZN). The concept of showrooming (browsing in person and then buying online), hits at the heart of what's going on at Best Buy. In theory, Best Buy has become a giant showroom for Amazon and other online retailers. This is somewhat true, and I've written in the past that Best Buy has some opportunities to adapt their business model to changing consumer tastes. Best Buy is good at mobile, and their recent annual report shows the potential the company has. Let's look at the numbers and I'll show you what I've found.

First, we need to get a sense of the size and scope of Best Buy. I think many people believe Best Buy is a U.S. electronics chain. Look at the stores and locations that Best Buy already operates:

As you can see there are lots of moving pieces and out of the 4,120 locations, 26.77% are the traditional U.S. big box stores. The difference between Best Buy U.S. and Best Buy International, has a lot to do with concentration on mobile versus other categories. If the company keeps its current plans, Best Buy will open about 100 Best Buy Mobile stores in the U.S. and close 50 big box stores. In addition, the company expects to open about 50 more stores in China. Total stores would increase to 4,220 and the percentage of big box stores would drop to 24.95%. Long story short, Best Buy is becoming more of a mobile sales chain and less of a big box retailer.

Problem Categories:

The categories that Best Buy is having trouble with, are the ones that primarily go in their big box stores. The company specifically mentioned the following categories are problem areas: televisions, notebook computers, gaming and music. None of this should be a big surprise. Televisions have widely been a category that lends itself to showrooming. In theory, a buyer can go into a Best Buy, see the different televisions, then go to Amazon.com and buy the same model at a cheaper price. Since there is little Best Buy can do to differentiate itself in this area that makes sense, gaming and music are both in transition. While I would expect gaming to pick up with the launch of new titles and new consoles, music has been constantly moving toward online sales.

Growth Categories:

The categories Best Buy sees positive momentum in are equally not surprising: tablets, e-readers, accessories and services. Tablets and e-readers for all of their popularity are still a relatively new category. Many customers don't know enough about each device to make a choice online, so they go into Best Buy for advice and to play with the units. Since tablets and e-readers already have slim margins there isn't a lot of price competition. For instance, if you want a new iPad, you can walk into Best Buy and get it for $499 for the 16 GB wifi version, or you can go to Amazon.com and the price starts at $515 and that is not fulfilled by Amazon. Yes, you read that right, Amazon.com doesn't sell the new iPad directly from what I've found. The company fulfills orders from a few places, but the orders Amazon fulfills are priced even higher at $564.98 and more. As you can see, showrooming doesn't work very well when Amazon doesn't really want to sell the product.

Why Does The Move To Mobile Matter?

So why should investors care if Best Buy moves more toward mobile stores and away from the traditional big box stores? In short, the difference is in same store sales. In the last few years, there are two categories that Best Buy has consistently shown positive same store sales: Mobile and Appliances. Just as an example, while computing and mobile phones turned in a 3.6% positive same store sales in the U.S., the consumer electronics (cameras and televisions) division turned in negative 5.4% same store sales. Another example is, while appliance sales were up 7% in 2012 on a same store basis, Entertainment sales (gaming, music, movies) were down 16.3%. Long story short, Best Buy is strongest in mobile phones and appliances. The Best Buy of the future could look very different than the big yellow and blue buildings most people think of today.

The Best Buy Of The Future:

Whereas the company has about 4,100 stores and by the end of 2012 about 25% will be big box stores, I think the future of Best Buy is the Best Buy Mobile concept. In a few years, I wouldn't be shocked at all to see the big box stores drop to somewhere around 10-15% of the total store count. Best Buy knows that they can't keep running all of these huge stores that really only sell two or three categories. Best Buy Mobile stores in the future should consist of: mobile phones, tablets, e-readers, a few notebooks, Geek Squad, and some display appliances. Mobile service is recurring and a more predictable business than electronics. Mobile is constantly evolving with new phones, new plans, and new devices. Best Buy Mobile locations will likely morph into something in-between the big box store and the traditional mobile store. Something about a quarter of the size of your traditional Best Buy store sounds about right. This Best Buy is more nimble, more cost efficient, and more profitable.

Conclusion:

It will take some time for this transition to occur, but the company is already moving in that direction. In the meantime, the company is trying to give back whatever they can to shareholders. In the last year the company bought back 12.79 million shares at an average price of $24.76, nearly 23% higher than today's price. The company still has over $4 billion left under the current buyback program. If you don't really understand accounting, Best Buy looks like they took a major earnings hit in 2012. That isn't the case, as a $1.2 billion goodwill impairment charge hurt earnings, but then was added back under cash flow. If you adjust for both, net income was down about 12.88%, but operating cash flow was actually up 75% to over $2 billion. The dividend is well covered with $234 million in dividend payments using less than 15% of free cash flow. The transition of Best Buy from traditional big box retailer to mobile sales leader will take some time. Investors should expect slow revenue growth, but better same store sales, margins, and free cash flow. Once the number of mobile stores begins to take over, revenue growth should pick up again. Best Buy isn't dying, they are adapting, there is a difference.

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