Best Buy’s $21 Price Estimate: Key Business Trends To Watch

by Trefis Team
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Best Buy
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Best Buy (NYSE:BBY) is one of the leading retailers of consumer electronic products with stores in the U.S., Canada, China and Mexico. It entered into a joint venture with Carphone Warehouse in 2008 to tap the growth potential in Europe but exited the market earlier this year by selling its 50% stake in Best Buy Europe to Carphone. With over 1.6 billion visitors to its websites and stores every year Best Buy is the largest specialty retailer of consumer electronics in the U.S. In also offers technology services in addition to selling a variety of brands of electronic devices.

The growing competition from retail giants including Amazon and Wal-Mart has restricted Best Buy’s top line growth in the last few years. Though the company has come out with innovative schemes to re-accelerate its business, the move has impacted its gross margins which in turn put pressure on its bottom line. Nevertheless, in the last two quarters Best Buy has shown improving results backed by an encouraging holiday season and its permanent price matching policy. In addition to the above factors, the speculation surrounding the buyout offer (now abandoned) by founder Richard Schulze contributed to a more than 100% rise in Best Buy’s stock price.

With a price estimate of $20.64, we maintain a cautious outlook on Best Buy. In this article we list the key drivers that make up RadioShack’s business and discuss certain recent trends that impact its performance.

See our full analysis for Best Buy

Best Buy’s Key Business Segments

Best Buy earned $44 billion in sales in 2012 (calendar year) and earned 23.7% gross profit on the same. It registered a 14.4% decline in its annual revenue on account of macro weakness combined with intense competition in the market. We believe that the company’s current initiatives will help revive its business but forecast a declining trend in revenues over our review period.

We have broken down Best Buys’s business in the following categories:

1. U.S. Stores – This division includes revenue earned from Best Buy branded stores in the U.S. which offer a wide variety of consumer electronics, home office products, entertainment software, appliances and related services and certain non-core offerings like beverages & snacks. Best Buy derives majority of its revenue (67%) and earns 23.5% gross profits from this division. It currently operates over 1000 branded stores in the U.S. with an square footage per store and revenue per square foot of 37,700 and $726.

Best Buy plans to close 50 U.S. Best Buy big box stores in fiscal 2013, expects a reduction in square footage for certain of the large-format stores. We therefore expect square footage per Best Buy store to decline over our review period. Due to the high competitive pressure from online firms like Amazon and eBay we forecast lower average annual revenue per square feet.

2. International Stores – This division consists of stores operating under the Best Buy brand in Canada, China and Mexico as well as Future Shop and Five Star retail chains in Canada and China, respectively. These stores offer merchandise across almost all categories. Best buy derives 25% of its revenues from the 487 international stores and earns a gross margin of approximately 24% on the same. The average square footage per international store and revenue per square foot is 28,400 and $818 respectively.

In an effort to tap the growth opportunities in international markets, Best Buy intends to continue expanding its operations in markets outside the U.S. However, we expect the Square Footage per Best Buy Store to decline in the coming years as Best Buy looks to optimize its store size for better efficiency and productivity. Additionally, we do not forecast any significant improvement in revenue per square foot as the company faces intense competition in the international markets as well.

3. Stand-Alone Mobile Phone Stores: This category essentially refers to standalone Best Buy Mobile Phone stores that primarily derive their revenue from sales of mobile phone hardware, subscription service commissions and mobile-related accessories. It also sells products such as laptops, gaming consoles, accessories and software across three store brands - Best Buy Mobile in the U.S. and the Carphone Warehouse and Phone House Stores in Europe. Best Buy derives approximately 7% of its revenue from this division and we do not anticipate any significant change in the trend.

4. Pacific Sales, Magnolia Audio Video and Others: Pacific Sales specializes in the sale of ultra-premium and mass-premium kitchen appliances, plumbing fixtures and home entertainment products. Magnolia Audio Video sells audio and video products like TVs, DVD Players, Home Theater Systems, Mobile Electronics etc. Best Buy derives less than 1% of its revenue from these two formats and earns 23.5% gross profits from this division. We expect the revenue contribution to remain around 1% for the rest of our review period.

Key Trends Impacting Best Buy’s Valuation

1. Showrooming challenge faced by the consumer electronics retailing industry

Showrooming, a phenomena where customers use physical stores to check out products and gain hands-on experience with gadgets but use online stores to make the purchase, has negatively impacted sales of traditional brick-and-mortar retailers. The entry of online retail giants such as Amazon has altered the landscape for the consumer electronics market.

Earlier this year, Best Buy announced making its price-matching policy permanent in order to put an end to showrooming. Best Buy put in place a permanent “Low Price Guarantee” policy on March 3. Under this policy, the company will price match all local retail competitors and 19 major online competitors in all product categories and on nearly all in-stock products, whenever asked by a customer. This guarantee is available on Best Buy’s website at more than 1,000 Best Buy big box stores, more than 400 Best Buy Mobile standalone stores in the U.S. as well as on the telephone. The company claims to be witnessing a positive response for the policy so far.

Additionally, Best Buy is set to benefit from the “Marketplace Fairness Act” which has made it through the Senate. The bill is designed to bring online retailers under the sales tax purview to give physical retailers a level playing field and will now be discussed by the House of Representatives. Best Buy claimed that it is already witnessing increased sales in states where sales tax from Amazon customers is now being collected. [1]

2. Declining gross margins due to competition and lower prices

In addition to increasing competition, Best Buy’s “Low Price Guarantee” has lowered its gross profit. Gross profit margin for last quarter stood at 23.1%, down from 24.9% recorded last year.

In order to improve gross profit per square foot, Best Buy plans to focus on stocking more items that generate higher margins. Therefore, it has reduced the stock of CDs and DVDs in its stores and is allocating  more store space to mobile and computing products. Simultaneously, it will seek to reduce costs through intelligent inventory management and supply chain optimization.

3. Renew blue program to help turn around the company

Earlier this year, Best Buy outlined certain key initiatives under the “Renew Blue” program to turnaround the company. Accelerating its online segment, which constitute less than 10% of its store revenues, remains its main focus. The company intends to increase online traffic and increase the conversion rate among visitors by providing a more interactive shopping experience. Its initiatives resulted in a 16% increase in domestic comparable online sales last quarter.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:
  1. Best Buy Q1 2013 Earnings Conference Call, Seeking Alpha []
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