On its face, Best Buy (NYSE:BBY) looks far too cheap. Best Buy stock trades right at 12x the midpoint of fiscal 2020 (ending January) EPS guidance. Considering Best Buy is growing steadily — EPS rose 20% in fiscal 2019 — the multiple assigned BBY stock seems far too low.
However, I’d say Best Buy stock looks priced about right — at best. Much of last year’s earnings growth came from a lower tax rate. Underlying growth is expected to decelerate this year and that could continue going forward. Cyclical risks are rising, and Best Buy’s key suppliers don’t necessarily seem all that healthy.
The news admittedly isn’t terrible. BBY stock hardly seems like a short, and there are worse plays out there, particularly in retail. But there are risks that investors need to monitor. And there are reasons why Best Buy stock looks cheap… because it probably should be cheap.
The Case for Best Buy Stock
The case for Best Buy stock is relatively simple — even beyond valuation. Historical performance has been impressive: Best Buy has grown earnings through a combination of underlying growth, share buybacks and a lower tax rate. BBY stock bottomed near $10 in late 2012; six and a half years later, it’s returned over 600% including dividends.
Competition is essentially nil — at least in terms of brick-and-mortar rivals. Amazon.com (NASDAQ:AMZN) is an obvious threat. But Best Buy has managed through worries about the “showroom effect” – and outlasted former competitors like Circuit City, RadioShack, and hhgregg. Best Buy is basically the last major retailer standing to serve an enormous market.
More recently, Best Buy is coming off an impressive earnings report. Adjusted earnings came in well ahead of consensus expectations. Same-store sales growth of 3% was solid in a quarter where several retailers stumbled and capped an impressive full-year comp increase of 4.8%.
Best Buy is a good business with limited competition. The company is executing well — including driving online sales (up over 10% in fiscal 2019). BBY stock is cheap. What can go wrong?
The Risks to BBY Stock
Quite a bit, actually. There are real risks here and real reasons why Best Buy stock receives a basically zero-growth 12x multiple.
Near-term growth is decelerating. After 4.8% and 5.6% comp growth the last two years, Best Buy expects just a 0.5%-2.5% increase in fiscal 2020. Operating margins are expected to be flat — and narrow, at just 4.6%. The midpoint of EPS guidance suggests a little over 4% growth year-over-year.
Best Buy could outperform, admittedly. And at 12x earnings, any growth could suggest upside. A 3% dividend yield helps the case as well. But looking forward, there are two key risks here.
The first is that Best Buy has a good deal of cyclical exposure. Spending on big-ticket items like televisions and computers slows dramatically when the macro picture weakens. Best Buy itself saw same-store sales decline a total of 2.5% from fiscal 2009 through fiscal 2011 — even as competitors were vanishing.
If and when the economy turns, Best Buy earnings very well could decline — and the stock would follow. Even renewed fears of a cyclical downturn can hammer BBY stock: note that shares dropped almost 40% just between early October and mid-December.
Is Electronics a Good Business?
The second, broader concern for BBY is the health of the electronics space. Prices for many Best Buy products keep dropping. Computing and mobile devices drive over half of sales. Neither business looks particularly healthy at the moment.
Indeed, it’s worth considering Best Buy’s biggest suppliers. 56% of inventory purchases in fiscal 2018 (this year’s 10-K hasn’t been filed yet) came from Apple (NASDAQ:AAPL), Samsung, HP (NYSE:HPQ), Sony (NYSE:SNE) and Lenovo (OTCMKTS:LNVGY).
Apple’s domestic sales, particularly of the iPhone, are a significant question mark. At the least, it does look like the ever-increasing prices for the iPhone are going to have to moderate, with the company already cutting prices. HP stock just plunged on a revenue miss. Sony’s game business — the most important to Best Buy — is struggling as well.
The long-term trend for key Best Buy categories is for pricing to stay flat at best. With operating margins under 5%, Best Buy earnings don’t have much room for pricing compression.
In that context, a 12x multiple seems reasonable — and maybe a touch expensive. Cyclical pressures will show up at some point. Even a cursory look at key suppliers shows that secular pressures already are here. The long-running benefit of dying competition is fading, with only GameStop (NYSE:GME) left to cede sales.
Clearly, there are risks here for Best Buy stock. From here, those risks suggest that BBY stock could be — and should be — even cheaper.
As of this writing, Vince Martin has no positions in any securities mentioned.
