The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
On Wednesday, Best Buy (NYSE:BBY) announced changes to its business segments, which will result in executive departures. Senior executives, including Mike Vitelli, President of Best Buy’s U.S. business, will step down at the end of the year in order to make way for a revised business structure. As of January 1, Best Buy will begin reporting in two channels: Online and Retail.
Best Buy also negatively pre-announced Q3 earnings. Same-store sales are expected to range from down 5.3% to down 3.2%. Our comp assumption goes to down 5.3% from down 9.7% previously. Gross margin is expected to be down 100 bps y-o-y, so we have lowered our gross margin assumption to 23.2% from 24.0%, substantially impacting profitability. SG&A margin y-o-y growth will be low-singledigits, in-line with our model (22.4% SG&A margin). The pre-announcement made clear that Q3 non-GAAP EPS will be significantly lower than last year, reflecting a number of initiatives designed to drive traffic and improve service, such as free shipping, employee training, and price matching through the holidays. The net result is that gross margins continue to erode, while expenses continue upward, resulting in substantially lower earnings, for the current quarter at a minimum. Our Q3 EPS goes to $0.14 from $0.28 previously, compared to consensus of $0.36.
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Best Buy will host an analyst day on November 1 in New York. The event will be webcast and will be hosted by Hubert Joly, Best Buy President and CEO.
We believe Best Buy must focus on formulating and executing a plan to substantially reduce its high store level overhead; a key competitive disadvantage to its online peers. We believe that Best Buy’s store level economics place it at a ≈ 10% price disadvantage to online retailers, and we believe that increasingly sophisticated consumers with mobile Internet access will value lower prices over service, ultimately making Best Buy’s big boxes obsolete.
We reiterate our UNDERPERFORM rating and 12-month price target of $14.50, which reflects low visibility, lack of FY:13 guidance, our view that a takeover is unlikely, and our doubts about the company’s new CEO. We believe Best Buy has been unable to stem sustained comp declines and eroding margins, and remains at a significant disadvantage to its lower-priced and lower-cost peers. Our price target reflects a P/E multiple of ≈ 5x our FY:14 EPS estimate of $2.90, and is well below Best Buy’s historical 12 – 15x multiple.
Michael Pachter is an analyst at Wedbush Securities.