We recently revised our price estimate for electronics retailer Best Buy (NYSE:BBY) from $21.64 to $26.21, a 25% increase. The company reported its third consecutive quarter of better than forecast earnings and posted its first quarterly profit in a year, in Q2 2014. Since then its stock price has increased by more than 25% and is trading at its highest in over two years. (Read our earnings article: Best Buy’s Earnings Improve On Its Turnaround Strategy)
Despite our updated price estimate, we remain cautious about the company’s future growth prospects. In this article, we highlight the recent changes made in our model for Best Buy.
A Stronger Balance Sheet Led To Significant Upside
Best Buy’s cash & cash equivalent at the end of Q2 2014 increased to $1.97 billion from $1.44 billion in the previous quarter. The company’s cash base has expanded on account of the payment received for selling its 50% stake in Carphone Warehouse and lower interest payments by refinancing its debt. Additionally, during Q2 2014 Best Buy reached settlements with multiple defendants under which it will receive a total of $229 million net of litigation costs.
Best Buy also lowered its debt obligation, including short-term debt, long-term debt and the current portion of long-term debt, from $2.29 billion at the end of fiscal 2012 to $1.68 billion at present. The current portion of its long-term debt declined from $544 million in Q1 2014 to $44 million in Q2 2014 due to the issuance of a new 5%, 5-year $500 million bond, which replaced a 6.75% $500 million bond that matured in July.
In our model we have included the following line items to arrive at total debt obligation for the company – long-term debt (including current portion), short-term debt, minority interest as well as the present value of total operating lease obligations. Our total debt estimate for Best Buy has decreased from $11.29 billion to $8.48 billion at present.
The resultant change in the net cash balance led to an approximate 30% increase in our price estimate for Best Buy.
Factors That Offset The Increase In Valuation
Below are some of the key factors that offset the increase in the price estimate due to the higher net cash balance.
1. Extending the forecast period to 2020: We extended our forecast period by an year, to 2020. Since we forecast a marginal declining trend for revenues as well as margins, our price estimate declined by almost 5%.
2. Marginal decline in our estimate for 2013 revenues: In line with Best Buy’s performance in Q1 and Q2 2014, we have reduced our revenue estimate for 2013 from $42.6 billion to $40.7 billion. This led to a marginal decline in our price estimate.
- Lower average revenue per square feet: We now expect the revenue per square feet for both the U.S. international markets to decline by 5% in 2013, against our initial estimate of a 0.5% decline. The growing competition from online retail giants continue to impact Best Buy’s business. Additionally, the closing down of some stores and the revamping of existing stores is putting pressure on revenues. In its recent earnings call, Best Buy highlighted that the deployment of the Microsoft stores is more disruptive than the initial work on the Samsung Experience shops, and thus we expect them to offset top line growth till Best Buy completes the deployments of the project.
- Declining number of U.S. stores: Best Buy plans to close 50 U.S. Best Buy big box stores in fiscal 2013. Our initial estimate was that the company will close down 40 stores. A decline in the number of stores will directly impact revenue growth.