(Published March 10 by Bob Ciura)
Retail has always been a difficult business, but it has become even more challenging lately, due to the e-commerce boom.
Amazon.com (AMZN, Financial) and other internet retailers are dangerous threats to most brick-and-mortar retailers.
Consumers are clearly loving the convenience of at-home delivery, and Amazon.com can offer lower prices than can be found at many physical stores.
This has put intense pressure on the retail industry. Many retailers have responded by closing stores.
Best Buy (BBY, Financial) has bucked the overall trend of retail weakness that is spreading across the industry.
Best Buy performed well in 2016 and recently rewarded shareholders with a hefty 21% dividend hike.
It is a Dividend Achiever, a group of 271 stocks with 10-plus years of consecutive dividend increases. You can see the full Dividend Achievers List here.
Best Buy has proven that there is a way for brick-and-mortar retailers to compete with Amazon.
Business overview
It wasn’t too long ago that Best Buy was left for dead because it seemed to be directly in Amazon’s crosshairs.
At the end of 2009, Best Buy was a $40 stock. By the end of 2012, it was trading for just $11.
Investors were convinced that Best Buy was on a similar path of so many electronics retailers, like RadioShack and Circuit City.
Comparable-store sales, an important metric that shows performance at stores open at least one year, fell 2.6% in fiscal 2013 (calendar year 2012).
Source: 2016 Annual Shareholder Letter, page 5
This decline mirrors what many other retailers are seeing right now.
But Best Buy quickly returned to growth, and the stock is back to $44.
It has engineered a remarkable turnaround. Last year, comparable-store sales rose 0.9%, the highest growth level in the past six years.
The first thing Best Buy did to restore its growth was to build up its e-commerce platform.
Once it became clear that e-commerce was here to stay and that Amazon represented a real threat, Best Buy had no choice but to adapt.
The result is that it now has a strong online presence. In fiscal 2017, Best Buy’s online sales increased 20.8%.
E-commerce accounted for 18.6% of total U.S. revenue in the fourth quarter compared with 15.6% in the same quarter the previous year.
Separately, Best Buy has accelerated its turnaround with a product mix shift.
When Best Buy announced its turnaround plan in 2013, called Renew Blue, it saw an opportunity to reinvent itself around appliances and smartphones.
Source: Renew Blue Investor presentation, page 5
It has been a subtle change, but over the past three years, Best Buy has refocused its product offerings around these two product areas.
At the same time, the company reduced its allotment of products deemed as old technology, such as DVDs and CDs, or products most vulnerable to be “showroomed.”
Showrooming, in which consumers would come to stores to view products in person only to purchase them online, was a troubling trend for Best Buy.
This trend was one of the causes Best Buy management attributed to its sales declines in 2012 and 2013.
That is because appliances, smartphones and tablets have proven to be resistant to Amazon’s seemingly unstoppable takeover of the retail industry.
To stay on track, Best Buy has announced a new set of growth priorities called Best Buy 2020.
Growth prospects
Best Buy’s strategic initiatives have led to excellent earnings growth. In 2016, Best Buy’s adjusted earnings per share increased 28%.
Best Buy 2020 will expand on what has worked well over the past few years and develop new initiatives.
Among the core imperatives for Best Buy 2020 are the following:
- Maximize the multichannel retail business.
- Expand services and solutions businesses.
- International store openings.
At the center of the plan is catering to changing consumer habits. Technology is evolving quickly. Best Buy believes it is in a unique position to maximize its capabilities.
When Best Buy started Renew Blue, it had 75 million Reward Zone members.
Source: Renew Blue Investor presentation, page 12
It has continued to grow the program since then. Best Buy’s large and loyal customer base will help the company reach its next set of goals even faster.
Best Buy has an expansive store footprint and is building its Geek Squad services, which it believes will help maximize its in-store capabilities.
Plus, Best Buy intends to boost its international operations. It plans to open nine new stores in Mexico over the next two years.
It is becoming much more profitable in international markets. Fourth-quarter adjusted gross profit margin expanded by 280 basis points from the same quarter of the previous year.
Finally, cost cuts will also be a boost to earnings growth. Last year, the company expanded operating profit margin by 80 basis points to 6.7%.
Accelerating revenue growth and cost savings should result in continued earnings growth going forward. On average, analysts expect Best Buy will grow earnings per share by 6.1% in 2017.
Dividends
Since the Renew Blue turnaround plan gained traction, its financial performance has greatly improved.
Over that time, Best Buy grew adjusted earnings per share by 9% per year. It expanded return on invested capital from 10.8% to 18.9%.
For 2016, Best Buy generated $2 billion of free cash flow. Its successful turnaround has given the company additional leeway to return cash to shareholders.
Last year, Best Buy returned $1.2 billion through dividends and share repurchases.
For 2017, the company announced a 21% dividend increase as well as a $3 billion share repurchase authorization.
The $3 billion in share buybacks will be spread over the next two years. At approximately $1.5 billion per year, Best Buy could reduce its share count by 10% each year.
Share repurchases have been a key component to Best Buy’s earnings growth strategy. Last year, the company reduced its weighted-average diluted share count by 8%.
Going forward, Best Buy’s annualized dividend rises to $1.36 per share, which represents a 3% dividend yield. The company’s dividend yield combined with share repurchases gives it one of the highest shareholder yields (dividends plus stock repurchases) of any business at 13%.
Final thoughts
There are many solid dividend growth stocks in the retail industry, but few have generated Best Buy’s level of dividend growth in the past three years.
Best Buy has been a rare example of a retailer that can successfully fend off Amazon.
Best Buy’s competitive advantages – focusing on appliances and smartphones, its huge rewards program and international growth –Â could allow it to continue raising its dividend at high rates.
Disclosure: I am not long any of the stocks mentioned in this article.
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