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Best Buy – 15% Drop in a Day; Opportunity or Classic Value Trap?
Posted by: Anh Hoang (IP Logged)
Date: December 14, 2011 07:40AM
Best Buy (BBY), the multinational retailer of consumer electronics, home office products, entertainment products and appliances, has experienced more than 15% drop in its stock price in just within a day, right after it announced a. profit fall in the third quarter.
In a conference call yesterday, Brian Dunn, Best Buy CEO, has commented on the overall strategy and what has affected the third-quarter result of the business. He said that the company has taken decisive actions to drive the business, specifically in revenue and market share, both in-store and aggressively online. Although it impacted the gross margin negatively, it would boost the improved traffic of consumers to the stores and the comp sales. So that was the preparation for the upcoming holiday season. The domestic comp sales were up 1% for the quarter and were strengthened by November’s performance. The in-store comps on Black Friday were strong, delivering overall comp of 7% for the day. According to the third party survey, Best Buy ranked No. 1 place to shop in CE and technology. For all of retail, it ranked No. 2 in initial shopping destination, and it was the third most-visited U.S. retail website on Black Friday, up from fourth place last year.
On the financial side, the third quarter experienced a 29% drop in profit as it increased the markdowns on tablets, TVs and movies to fuel customer traffic and sales. The net income fell to $154 million, or 42 cents per share compared to $217 million or 54 cents/share a year ago. The firm took $150 million of pretax restructuring costs for the closure of 11 big box pilot stores in the UK.
If excluding the one-time items such as restructuring cost, Best Buy made 47 cents per share on adjusted basis. James Muehlbauer, the CFO, noted that third-quarter results actually reflected two different periods of consumer purchase behavior. September and October was still a non-holiday period, and November was the beginning of the very important holiday season, especially with the big Black Friday promotion in this month. He said it was important to assess the performance for the full November and December period to get a more complete view of customer behavior and business performance for the holiday. And for Best Buy, the significant earnings was derived in the month of December. So the full effect of preparation and investment into the promotions for upcoming holiday seasons can only be judged in the fourth-quarter result.
During the quarter, Best Buy made incremental decisions to invest in additional promotional activity in several areas such as computing, television and movies and the executives were satisfied with strong response they saw from the consumers. In this current financial conditions, consumers were more value and promotion-oriented when it came to shopping. Even with the profit decline, Best Buy still kept generating a lot of cash. Free cash flow through the third quarter reached $2 billion, and it was on track to deliver the adjusted free cash flow target of $2 to $2.5 billion.
A lot of value investors have been accumulating Best Buy over time, since it was the retailer which kept delivering double digit return on equity for the last eight years and had quite positive, even fluctuating, operating cash flow and free cash flow. Now there are around eight gurus holding a stake in Best Buy.
As Best Buy is a typical consumer electronics retailer. It has to face fierce competition from Walmart (WMT) and especially Amazon (AMZN). A lot of people might consider it a value trap. It looks like it has a good valuation for value investors but it might even trade at a greater discount. However, it has a P/E of 8x, P/CF of 3.8x, whereas the average five-year valuation has been nearly two times higher for P/E and nearly three times higher for P/CF. It shouldn’t be omitted entirely because of the business' competitive environment, especially as the business keeps producing positive free cash flow over time.
This stock could be worth considering at the current price, if you watch the business carefully. In February, when it released its fourth-quarter result, subjectively I thought it would have quite a pleasant quarter compared to the third-quarter result, and the stock might react positively to that. Nevertheless, Best Buy should not make the largest holding; it should be in a diversified basket of anyone’s value investment portfolio.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.