Thursday, September 27, 2012

Fabulous Fourth Quarter Boosts Best Buy

Best Buy (BBY) is the undisputed market leader in consumer electronics retail, and they reported fiscal fourth quarter results above estimates for the period that includes the end of the holiday shopping season. The results were better than analysts’ expectations on both sales and profits. Net income rose to $779 million or $1.82 per share ahead of analysts’ estimates by 4 cents and up substantially from last year’s $570 million or $1.35 per share. Sales in the quarter were better across the board rising 12% overall, and 7% in comparable store figures. International growth was a highlight of the quarter as sales rose 15% (5% on a constant currency basis) with China being particularly impressive with a 34% increase, and international same store sales jumped 5.5%. The top-line figure was $16.6 billion, which is $500 million stronger than consensus Wall Street estimates, largely because of the strong performance overseas.

While international sales a key driver of Best Buy’s growth, they also increased market share in the United States as it continues to reel-in shoppers that might have otherwise gone to now bankrupt Circuit City. Shoppers spent more on average, but margins were squeezed a little bit from sales of lower margin products such as notebook computers and pricing pressure on flat screen TV’s. In the quarter, gross margins slipped about 60 basis points to 24% even as selling, general and administrative expenses dropped 70 basis points. However, the overall performance of the company has propelled the stock to a more than 8% gain in morning trading, despite the slip in margin.

Further helping the stock is managements better than expected outlook for fiscal 2011. They have come out with earnings guidance of $3.45 to $3.60 on sales of $53 billion, and same store sales gains of 1% to 3%. This topped Wall Street’s view of $3.37 in earnings on sales of $52.2 billion. The company has reinstated the $2.5 billion share repurchase plan that it had suspended when the market environment was less hospitable.

Based on the recent performance of Best Buy and their optimistic outlook for the year ahead, we think the stock remains cheap even after the rally today and we are reiterating our Undervalued stance. In my opinion, this company’s market leading position in consumer electronics and its international growth should warrant a premium over its historical valuation in the market; however, the opposite is actually true as it trades at a discount to historical valuation ranges. For example, over the last ten years BBY has traded for price-to-cash earnings of 9.2x to 18.7x, but the current valuation is only 8.5x. Similarly, on a price-to-sales basis BBY has normally traded for .43x to .83x, but based on sales figures from the year that just ended, the current metric is only .37x. So, we believe the market will return to more historically normal valuations for Best Buy given its strong execution and projected growth in the coming year, which makes our expected price range of $46 to $60 per share.

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