Best Buy (NYSE:BBY) is the largest specialty retailer of consumer electronics in the U.S. and operates stores in Canada, China and Mexico. The growing competition from retail giants including Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT) has eroded Best Buy’s top line growth in the last few years. However, owing to Best Buy’s ongoing restructuring initiative, the company’s financial performance improved in fiscal 2014.
Best Buy witnessed a 6.5% growth in its revenue in fiscal 2014, while its net earnings (excluding discontinued operations) increased to $687 million compared to a net loss of $469 million in fiscal 2013. Best Buy’s stock price increased by approximately 200% in calendar year 2013. However, after hitting a 52-week high in November 2013 the company has seen a continuous decline in its stock value (more than 40%).
We feel that the recent decline in stock price brings about a correction in Best Buy’s valuation. Our price estimate of $26.38 for Best Buy is now at a 10% premium to the current market price. In this article, we list down key factors that contributed to the negative sentiment around Best Buy’s stock.
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Why Best Buy’s Stock Price Has Declined By 40% YTD?
– Dismal holiday sales: Best Buy reported a 2.6% decline in its 2014 holiday sales (9 weeks ending January 4, 2014) compared to the same period last year. Heavy sales promotion, combined with a weak consumer spending environment in the last three months, led to a 0.9% annual decline in Best Buy’s domestic comparable store sales. The aggressive promotional activity in the retail industry failed to accelerate industry demand and had a negative impact on Best Buy’s revenue.
Best Buy claims that its business was also hurt by supply constraints for key products, a drop in customer traffic, and a disappointing mobile phone market. According to research firm NPD Group, consumer electronics sales fell 2.4% to $22.9 billion during the 9-week holiday period. 
– Higher investment in pricing: In March 2013, Best Buy put in place a permanent “Low Price Guarantee” policy, under which it 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. The policy is an attempt by Best Buy to tackle the problem of showrooming, the phenomenon of potential customers using brick-and-mortar stores to browse through products only to order them online at cheaper prices. A 2012 Marketing Evolution Tracker survey indicates that according to 71% of its respondents Wal-Mart offered products at the lowest prices while only 23% of them believed that Best Buy did the same. 
Though the lower prices enhances Best Buy’s competitiveness in the market it puts pressure on its bottom line. The company’s gross profit margin declined from 24.2% in fiscal 2012 to 23.3% and 22.8% in fiscal 2013 and 2014 receptively.
– Negative impact of mobile warranty & new credit card agreement: Best buy’s Q4 2014 operating income declined by 1.2% which included a 1% negative impact of its mobile warranty program and the new credit card agreement. The company entered into a new credit card agreement with Citibank in September 2013, which negatively impacted Best Buy’s gross profit. The company claims that the economics of the new agreement are less favorable than the expired agreement due to changes in both the regulatory environment and overall consumer credit market. Additionally, Best Buy’s product warranty cost went up in the latter part of fiscal 2014 on account of higher claims frequency in the mobile phone category and the lower attachment rates on mobile service plans.
– Best Buy’s stock price declined by 6% earlier this month after the abrupt departure of the president of its U.S. retail stores, a 29-year company veteran. The fact that 48-year old Shawn Score resigned only seven months after being promoted to his new position was not well received by the investor community. Adding to investor concerns, no doubt, was the negative pre-announcement that day of H.H. Gregg, a small regional electronics retailer with a market cap of $263 million.
Best Buy remains confident that its turnaround strategy will re-accelerate its growth in the future. It claims to have made significant progress against several Renew Blue priorities, which it believes leaves it well-positioned to enter fiscal 2015. We will cover these key developments in our subsequent article.Notes: