Best Buy [NYSE:BBY] Sep. 17, 2009: $37.59
52-week range: $16.42 (Nov. 21, 2008) - $48.99 (Sep. 19, 2008)
Dividend = $0.14 quarterly = 1.49% current yield
Best Buy is the largest specialty retailer of consumer electronics in North America, with about 1,100 stores in the U.S. and Canada. The company sells video and audio equipment, computers, and home appliances. Best Buy operates electronics stores in Canada and China under the names Future Shop and Five Star, respectively, and specialty stores Magnolia Home Theater, Pacific Sales Kitchen and Bath, and Geek Squad in the U.S.
FY 2008 (ended Feb. 2009) marked the first year-over-year decline in EPS since 1996. Zacks’ FY 2010 - 2011 estimates now are running $2.90 and $3.19 following last year’s $2.88 /share (excluding a $0.48 non-recurring loss). The demise of major competitor, Circuit City, has led to what may be a permanent gain in BBY’s market share.
At today’s close of $37.59 Best Buy shares now trade for < 13.7x this year’s and 11.8x next FY’s estimates. Those are a bit lower than the typical historical multiples for BBY.
Here are the split-adjusted, per share numbers from continuing operations as reported by Value Line:
FY ............ Sales ....... C/F ......... EPS ........ Div. .......... B/V ....... Avg. P/E
2002 ........ 43.37 ..... 1.93 ........ 1.27 ........ Nil ........... 5.65 ........ 17.1x
2003 ........ 50.41 ..... 2.43 ........ 1.63 ....... 0.27 ......... 7.03 ........ 18.8x
2004 ........ 55.70 ..... 2.82 ........ 1.91 ....... 0.27 ......... 9.03 ........ 18.6x
2005 ........ 63.59 ..... 3.29 ........ 2.27 ....... 0.31 ........ 10.84 ....... 19.2x
2006 ........ 74.76 ..... 3.92 ........ 2.79 ....... 0.36 ........ 12.90 ....... 18.6x
2007 ........ 97.48 ..... 4.84 ........ 3.12 ....... 0.46 ........ 10.92 ....... 15.1x
2008 ....... 108.82 .... 4.84 ........ 2.88 ....... 0.53 ........ 11.22 ....... 12.4x
Dividends were initiated in 2003 and have been increased in each of the past five years. The 1.49% current yield is competitive with today’s bank CD and short-term treasury rates. It looks very safe with about a 20% payout ratio.
Value Line is using a 16 multiple for their 3-5 year projections. Even 14x the current fiscal year estimate of $2.90 would bring these shares to a $40.60 target price by next spring. Standard and Poors has a 12-month goal of $41 while Morningstar sees ‘fair value’ as $52/share.
Is a $40 expectation a reasonable number? Best Buy shares have traded above that price during each calendar year since 2003. They exceeded $50 at their peaks in each year 2005-2006-2007 and 2008. They were above $42 in April this year. The yearly lows in 2006 and 2007 were $43.30 and $41.80.
A move from $37.59 to the low $40’s would be ok, but not exciting.
Here’s what I see as a better play than simply buying BBY shares.
............................................................ Cash Outlay ............... Cash Inflow
Buy 1000 BBY @$37.59 /share .................. $37,590
Sell 10 Jan. 2011 $40 calls @$5.90 /share ..................................... $5,900
Sell 10 Jan. 2011 $40 puts @$8.70 /share .................................... $8,700
Net Cash out-of-Pocket ............................ $22,990
If Best Buy rises to at least $40 (+6.5%) by Jan. 2011’s expiration date:
• The $40 calls will be exercised.
• You will sell your shares for $40,000.
• The $40 puts will expire worthless.
• You will likely have collected $840 in dividends.
• You will have no further option obligations.
• You will end up with no shares and $40,840 in cash.
That’s a best-case scenario total profit of $17,850/$22,990 = 77.6%
achieved on shares that only needed to move up by 6.5% over the 16-month time
horizon of this trade.
What’s the risk?
If Best Buy remains < $40 on the Jan. 2011 expiration date:
• The $40 calls will expire worthless.
• The $40 puts will be exercised.
• You will be forced to buy another 1000 BBY shares.
• You will need to lay out an additional $40,000 in cash.
• You will likely have collected $840 in dividends.
• You will have no further option obligations.
• You will end up with 2000 BBY shares and $840 in cash.
What’s the break-even on this whole trade?
On the original 1000 shares it’s their $37.59 /share purchase price
less the $5.90 /share call premium = $31.69 /share.
On the ‘put’ shares it’s the $40 strike price less the $8.70 /share
put premium = $31.30 /share.
Your overall break-even would be $31.50 /share (excluding yield) and $31.08 /share
if you include dividends.
BBY could fall by as much as $6.51 /share or (-17.3%) without causing a loss
on this trade.
Summary:
Best Buy is the category leader and on pace to hit $47 billion in FY 2009 sales. Debt is low at about 30% of total capital and financial strength is good (Value Line rates them ‘A’). Value Line sees ‘earnings predictability’ in the 95th percentile of their 1700 stock research universe (with 100th being best). Even the disastrous consumer spending environment last year (including competition from Circuit City’s liquidation sales) only saw a 7.7% drop in EPS.
While I don’t see a near-term catalyst for a huge move up, I do project a high probability that BBY shares will exceed $40 by January 2011.
Any move above 6.5% would give investors in this buy/write combination a cash-on-cash return of over 77% while providing a margin of safety of over 17% even if things don’t go as expected.
Disclosure: Author is long BBY shares and short BBY options.
52-week range: $16.42 (Nov. 21, 2008) - $48.99 (Sep. 19, 2008)
Dividend = $0.14 quarterly = 1.49% current yield
Best Buy is the largest specialty retailer of consumer electronics in North America, with about 1,100 stores in the U.S. and Canada. The company sells video and audio equipment, computers, and home appliances. Best Buy operates electronics stores in Canada and China under the names Future Shop and Five Star, respectively, and specialty stores Magnolia Home Theater, Pacific Sales Kitchen and Bath, and Geek Squad in the U.S.
FY 2008 (ended Feb. 2009) marked the first year-over-year decline in EPS since 1996. Zacks’ FY 2010 - 2011 estimates now are running $2.90 and $3.19 following last year’s $2.88 /share (excluding a $0.48 non-recurring loss). The demise of major competitor, Circuit City, has led to what may be a permanent gain in BBY’s market share.
At today’s close of $37.59 Best Buy shares now trade for < 13.7x this year’s and 11.8x next FY’s estimates. Those are a bit lower than the typical historical multiples for BBY.
Here are the split-adjusted, per share numbers from continuing operations as reported by Value Line:
FY ............ Sales ....... C/F ......... EPS ........ Div. .......... B/V ....... Avg. P/E
2002 ........ 43.37 ..... 1.93 ........ 1.27 ........ Nil ........... 5.65 ........ 17.1x
2003 ........ 50.41 ..... 2.43 ........ 1.63 ....... 0.27 ......... 7.03 ........ 18.8x
2004 ........ 55.70 ..... 2.82 ........ 1.91 ....... 0.27 ......... 9.03 ........ 18.6x
2005 ........ 63.59 ..... 3.29 ........ 2.27 ....... 0.31 ........ 10.84 ....... 19.2x
2006 ........ 74.76 ..... 3.92 ........ 2.79 ....... 0.36 ........ 12.90 ....... 18.6x
2007 ........ 97.48 ..... 4.84 ........ 3.12 ....... 0.46 ........ 10.92 ....... 15.1x
2008 ....... 108.82 .... 4.84 ........ 2.88 ....... 0.53 ........ 11.22 ....... 12.4x
Dividends were initiated in 2003 and have been increased in each of the past five years. The 1.49% current yield is competitive with today’s bank CD and short-term treasury rates. It looks very safe with about a 20% payout ratio.
Value Line is using a 16 multiple for their 3-5 year projections. Even 14x the current fiscal year estimate of $2.90 would bring these shares to a $40.60 target price by next spring. Standard and Poors has a 12-month goal of $41 while Morningstar sees ‘fair value’ as $52/share.
Is a $40 expectation a reasonable number? Best Buy shares have traded above that price during each calendar year since 2003. They exceeded $50 at their peaks in each year 2005-2006-2007 and 2008. They were above $42 in April this year. The yearly lows in 2006 and 2007 were $43.30 and $41.80.
A move from $37.59 to the low $40’s would be ok, but not exciting.
Here’s what I see as a better play than simply buying BBY shares.
............................................................ Cash Outlay ............... Cash Inflow
Buy 1000 BBY @$37.59 /share .................. $37,590
Sell 10 Jan. 2011 $40 calls @$5.90 /share ..................................... $5,900
Sell 10 Jan. 2011 $40 puts @$8.70 /share .................................... $8,700
Net Cash out-of-Pocket ............................ $22,990
If Best Buy rises to at least $40 (+6.5%) by Jan. 2011’s expiration date:
• The $40 calls will be exercised.
• You will sell your shares for $40,000.
• The $40 puts will expire worthless.
• You will likely have collected $840 in dividends.
• You will have no further option obligations.
• You will end up with no shares and $40,840 in cash.
That’s a best-case scenario total profit of $17,850/$22,990 = 77.6%
achieved on shares that only needed to move up by 6.5% over the 16-month time
horizon of this trade.
What’s the risk?
If Best Buy remains < $40 on the Jan. 2011 expiration date:
• The $40 calls will expire worthless.
• The $40 puts will be exercised.
• You will be forced to buy another 1000 BBY shares.
• You will need to lay out an additional $40,000 in cash.
• You will likely have collected $840 in dividends.
• You will have no further option obligations.
• You will end up with 2000 BBY shares and $840 in cash.
What’s the break-even on this whole trade?
On the original 1000 shares it’s their $37.59 /share purchase price
less the $5.90 /share call premium = $31.69 /share.
On the ‘put’ shares it’s the $40 strike price less the $8.70 /share
put premium = $31.30 /share.
Your overall break-even would be $31.50 /share (excluding yield) and $31.08 /share
if you include dividends.
BBY could fall by as much as $6.51 /share or (-17.3%) without causing a loss
on this trade.
Summary:
Best Buy is the category leader and on pace to hit $47 billion in FY 2009 sales. Debt is low at about 30% of total capital and financial strength is good (Value Line rates them ‘A’). Value Line sees ‘earnings predictability’ in the 95th percentile of their 1700 stock research universe (with 100th being best). Even the disastrous consumer spending environment last year (including competition from Circuit City’s liquidation sales) only saw a 7.7% drop in EPS.
While I don’t see a near-term catalyst for a huge move up, I do project a high probability that BBY shares will exceed $40 by January 2011.
Any move above 6.5% would give investors in this buy/write combination a cash-on-cash return of over 77% while providing a margin of safety of over 17% even if things don’t go as expected.
Disclosure: Author is long BBY shares and short BBY options.
