Big news of the past week from a corporate perspective was the terrific earnings report produced by Best Buy (BBY). As owners of the great SPDR Retail (XRT) fund, this is important because Best Buy is a major component and a bellwether for the rest of the industry.
Those of you who only started investing in the last five to ten years may not realize that there was a time when a BBY earnings report was a big deal. That time was from 1997 to 2000, when the innovative Minneapolis-based retailer soared 36x in a scorching ascent that seemed to persist virtually every day. It was the very definition of a growth and momentum stock, the likes of which we have rarely seen in the past decade.
BBY itself has spent the past decade consolidating from those prior glory days, as the future that was envisaged for it turned out to be very good but no earthly company could fulfill those expectations. Its experience, as shown in the chart above, illustrate why it is so important to buy growth stocks on the way up from very low levels if you want to make a killing because the long-term aftermath of those big moves rarely captures the old excitement.
Still a company like BBY continues to demand attention as its management continues to innovate like crazy. They have been at the forefront of a new concept in the five-day/40-hour work week, called “results-only work environment,” or ROWE, which throws away the old rules that equate office presence with productivity. The aim was to improve employees’ work/life balance by judging them on performance rather than hours spent in a cubicle.
Well it seems to be working, though having a sweet new lineup of gadgets to sell to a suddenly less frugal public isn’t hurting either. BBY reported fiscal fourth quarter earnings per share of $1.82 vs. consensus estimate of $1.79. The beat was largely driven by international sales (benefiting from the weaker U.S. dollar). And the company also lifted guidance for next year to $3.60 per share from $3.45, which implies year over year growth of 9.5% to 14.3%.
Management told analysts that they expect to obtain the improvements in the next year by boosting gross margins — and they expect to do that by selling higher-margin content and services bundled with the hardware. For instance, they’ll embed mobile broadband service in netbooks, and sell high-definition content packages with their high-definition TVs. This is what is known in industry as “making the basket more interesting” — not just selling the PC or TV in the sales cart, but enhancing the sale by also vending stuff to see and do with a long-term contract.
Rochdale Securities analyst Jaison Blair was telling clients he expects free cash flow to rise to well over $1 billion a year, which means the company can engage in shareholder-friendly activities like share repurchases that could reduce outstanding by as much as 8%. That would be fantastic, and is a very clever way to boost the share of your stock without burdening holders with new tax burdens.
Blair said his takeaway from the call was that investors’ expectations for BBY are too low, and that as the consumer spending cycle strengthens investors will put increasing value on the power of the BBY franchise. In other words, as fears about consumption fade, BBY will increasingly be able to up-sell its customers to higher-margin services, accessories and price points — especially as larger, flat-panel TVs are about to make a new leap into 3D and other enhancements.
All told, BBY is a great example of why retail is a bit of a bargain now despite its recent advance. The sector is still misunderstood and the focus of low expectations, and that means it’s cheap and has the potential to provide upside surprise. Within that universe, BBY is one of the cheapest, trading at 12x its fiscal 2011 range at a time when peers like Home Depot (HD) and Staples (SPLS) are trading at more like 17x forward earnings. It’s never going to rocket like it did in the late 1990s, but it could certainly double in three to four years with a combination of earnings growth and PE expansion.
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