by Dan Burrows | October 30, 2013 11:42 am
Best Buy (BBY) has been the best stock in the S&P 500 so far this year, rallying 262% on promising early results from its turnaround plan.
That’s an amazing reversal from 2012, when this bricks-and-mortar retailer was all but left for dead.
Intense, margin-crushing competition from the likes of Amazon.com (AMZN) and Wal-Mart (WMT) relegated BBY to little more than a showroom — a place where customers tried out gadgets in person before buying them elsewhere at lower prices.
Best Buy, already struggling for years, went into a deep funk in 2012. Best Buy stock had lost more than half its value by late autumn — and then the wheels fell off.
BBY suffered through a miserable holiday selling season. TV sales — a major source of revenue — were under pressure heading into the holidays thanks to lower average selling prices. But then Best Buy compounded its problems by making a heavy bet on 3D TVs, a technology that has been a bust so far.
By the end of December, Best Buy stock had fallen below $12 from $45 a year earlier. It looked like the only way Best Buy would survive was by going private in a management buyout.
But then things started to change.
Under new management, BBY slashed costs aggressively (something the market always loves) and moved to stop its problem with showrooming.
Closing stores and wringing $65 million in expenses out of operations during the second quarter demonstrated the crux of Best Buy’s turnaround strategy. But initiating a price-matching program (to keep customers from shopping online), improving its own online presence and building stores-within-stores for partners like Samsung (SSNLF) and Microsoft (MSFT) are gaining traction — and the market’s approval — too.
The problem for new investors is that usually when a stock nearly quadruples in 10-plus months, the easy money has already more than been made. The time to bet on a BBY turnaround was months ago — not necessarily now.
But plenty of Wall Street analysts are increasingly bullish on Best Buy stock, expecting significant fundamental improvement to materialize next year. The stock, heretofore rising mostly on sentiment, should have another leg up once sales, margins and profits start turning around.
So, should you buy Best Buy stock at current levels? To help decide, let’s look at some of the pros and cons:
Price Matching: Showrooming was killing BBY. Its stores were becoming nothing more than customer test centers. Just check out the picture on an LCDTV in person — and then make the actual purchase for less on Amazon. But Best Buy instituted a “Low-Price Guarantee” policy, where it will match any price. That should help stop showrooming in its tracks. Indeed, one market research firm says the program was responsible for a 10.5% increase in BBY online sales in the most recent quarter.
Untapped Online Potential: Best Buy lured online retail expert Sharon McCollum from Williams-Sonoma (WMS) to make something of its long-moribund website. That’s a fountain of untapped potential, given that only about 1% of BBY’s annual visitors actually buy anything. Other online retailers do about twice as well at converting visits into sales. If Best Buy can just improve enough to be average in this category, that will drive a critical stream of higher-margin revenue.
Partnerships: The store-with-store concept and other partnership agreements with important industry players are a tried-and-true way to drive traffic to the stores and create excitement over the brand. Best Buy is hardly a cool destination, but it becomes much more so when Samsung is unveiling its latest gadgets there. In another wise move, BBY has teamed up with Sony (SNE) and Microsoft to hold launch events for their next-generation consoles — Playstation 4 and XBox One — right before the holiday selling season kicks off.
Competition: BBY just launched an ad campaign trying to convince people not to shop on Amazon this holiday season. Meanwhile, Wal-Mart is increasingly focusing on BBY’s bread-and-butter of consumer electronics, a space where its Always Low Prices strategy poses an immense challenge to Best Buy. BBY might no longer be standing still, but then neither is the competition — and AMZN and WMT have much larger economies of scale. During last year’s holiday season, Amazon and Wal-Mart gained market share at the expense of Best Buy. That’s got to stop.
Valuation: BBY has been down so far for so long that it’s bound to look pricey at current levels, but some relative valuation metrics still give us pause. Price-earnings-to-growth (PEG) shows how fast a stock is rising relative to its growth prospects. In the case of BBY stock, shares are way ahead of future earnings growth. The PEG is greater than 4, well above a five-year average of 1.3 for Best Buy stock, according to data from Thomson Reuters Stock Reports. By comparison, the S&P 500, which doesn’t look so cheap itself these days, has a PEG of 1.9.
Operational Deleveraging: BBY is cutting costs, but it may not be slashing them fast enough — not the way revenue per square foot and TV prices are trending. Best Buy’s revenue per square foot declined consistently between 2006 and 2012, analysts at Trefis note, dropping to $726 from $953. Further declines are likely ahead — even as the company shutters stores — because of competition from storeless operators like Amazon and what looks like a secular decline in average selling prices for TVs. When you are a bricks-and-mortar company, you’ve got to squeeze more, not less, revenue out of your (very expensive) locations.
After such a hot run, it’s hard to call Best Buy stock a buy, but there probably is more short-term upside ahead. That’s how it works with momentum stocks and sentiment. This turnaround looks like it really is turning. Wall Street is increasingly bullish on the future for BBY, and traders and investors have a habit of chasing performance. It’s the allure of rising prices.
But the retailer has to show material improvement this holiday selling season for Best Buy stock to keep its mojo into the new year and beyond. Weak sales and further market-share loss to Amazon over the holidays could cause the sweet sentiment to turn sour very quickly.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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