How Best Buy’s “Renew Blue” Transformation Program Can Impact Its Valuation

Best Buy‘s (NYSE:BBY) gross margin for its U.S. stores declined from 25% to 22% between 2011 and 2014. U.S. stores account for more than 80% of our price estimate for the retailer. We expect the margin decline to continue over the forecast period with the figure reaching 18% in 2020. However, the “Renew Blue” transformation program launched by the company in 2012 with the goal of addressing declining comps and declining margins has now started showing results. Initiatives under this program include accelerating online growth,  improving customer experience, store space optimization, better partnership with vendors to drive value and focus on employee skills. As a result of this program, gross margin for Q2 2015 improved to 24.6%, as compared to 22% for the year 2014. There can be a 10% upside to our price estimate for Best Buy if gross margin remains stable around 22% over our forecast period.

Domestic Same Store Sales Are Improving

Best Buy’s comparable sales growth has been negative since 2011, except for fiscal year 2015, where it stood at +0.5% (excluding the impact of installment sales). There is a clear trend of improvement in the figure as evident from the chart below.

For the first two quarters of 2015, Best Buy’s comparable sales growth was 0.6% and 3.8%, respectively (including the impact of instalment sales). For the same period last year, the figure stood at -1.3% and -2%.  This shows a positive impact of the transformation program “Renew Blue” in addressing declining comps. Under this program, the company’s focus on price competitiveness, store upgrades and employee skills seems to be paying off. Furthermore, Best Buy has developed more strategic partnerships with its vendors to improve the value proposition for its customers. The improvement in same store sales has a direct positive impact on margins as fixed cost can be spread across higher revenues.

Stable Margins Can Lead To A 10% Upside In Our Price Estimate

The recent quarterly results have shown an improvement in Best Buy’s gross margin. This is especially notable considering the figure has declined consistently in recent years. The retailer’s gross profit margin for Q2 2015 increased to 24.6% compared to 23.7% for Q1 2015.  For the fiscal year 2015, this number was 22.4%.  Through its “Renew Blue” transformation program, the company has been able to achieve more than $1 billion in annualized cost reductions. ^[1]  The company has launched phase II of its Renew Blue cost reduction and gross profit optimization program, with a target of approximately $400 million in annualized savings over the next three years.  Through these initiatives, if it is able to arrest the projected decline in gross margins, there can be a 10% upside to our price estimate.

While factors such as competition from online retailers (Amazon, eBay) and large retail stores (Walmart), higher sales of low margin products, promotional expenditure to tackle competition put pressure on Best Buy’s margins, its cost reduction program is showing results.  If these results continue in the future, the above scenario is plausible.

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